January 3, 2010
In global economics, the two big stories of the past decade have been the rise of the middle classes in China and other formerly poor countries including India and Brazil, and the related weakening of the middle classes in formerly rich countries such as the US, Britain and, of course, Ireland.
The common denominator in both stories is debt and its handmaiden, credit. The new growing middle classes are presiding over economies that make things. In contrast, the old threatened middle classes are presiding over the gradual erosion of their economies, swapping production for consumption and savings for spending.
And, so long as we believe that we can get rich by borrowing money from the likes of China and Brazil, not to mention the Gulf countries and the ageing, prudential bastions of Germany and Japan, our middle classes will continue to suffer.
This simple problem, where some countries are spending too much and others are saving too much, is referred to by economists as creating ‘‘global imbalances’’. Ultimately, unless we cut back dramatically and wean ourselves off their debt, there will be another global financial crisis, which could dwarf the one we have just seen.
One of the major global policy dilemmas for the coming decade is whether we can achieve this reduction in our standard of living – bloated by unsustainable borrowings – without a massive crisis, which might not just be financial.
If you doubt the severity of the problem that the ‘‘rich but indebted’’ countries face, a quick look at history might be advisable – because, after all, economic history, even distant history, has a terrible habit of repeating itself.
Let’s see what happened a few hundred years ago, when a powerful country decided to live on credit, rather than production. Let’s go to imperial Spain, because the impact of South American gold on the Spanish economy was the 16th century equivalent of Chinese savings on the Anglo-American world in the 21st century.
In 1540, Juan Acosta returned from his second trip to the New World with a galley laden down with gold. The voyage, notwithstanding a scare involving English pirates off the Cuban coast, had been relatively uneventful. Eight years earlier, Acosta had accompanied Pizarro on that fateful day in Peru when the Spaniards garrotted Atahualpa, the Inca King. That week, the conquistadores had plundered more gold – as a ransom for the God King – than the entire continent of Europe produced in a year.
Acosta promised himself that this would be his last trip, and set about building himself the most extravagant villa in Cadiz. No expense was spared. Dutch tradesmen and expert woodcutters were transported from Amsterdam. Arab roofers and master tilers came in from Morocco. All carpets and curtains were bought at exorbitant mark-ups from Genoese merchants whose original sources in the Levant were impeccable. By 1546, the Acosta Villa was the talk of Andalusian society, as was Acosta himself, an amiable adventurer of humble origins.
Sixteenth-century Spain was awash with these rags-to-riches stories, and gold robbed from Latin America paid for everything. A monumental mass of gold and silver crossed the Atlantic between 1540 and 1580. In 1564 alone,154 ships, each carrying over 200 tons, docked in Seville. In the 50 years after the death of Atahualpa, the total amount of gold and silver in Europe increased fivefold. Almost every single ounce passed through Imperial Spain.
One would have thought that, given their windfall, the Spaniards would have been the richest people in Europe by the end of the century. But amazingly, Spain blew it. The impact of the flow of gold was felt elsewhere.
The Dutch, in particular, benefited enormously from Spanish gold.
There was hardly any lasting positive effect on the Spanish economy.
How did Spain manage to waste one of the biggest financial windfalls in human history? And are there any lessons for Ireland in the history of the Spanish gold rush?
Spain went on an almighty bender.
The Spaniards proved themselves to be better at spending money than saving the stuff, and acted like renaissance lotto winners, blowing their new money on anything they could get their hands on. They bought spices from the Orient, clothes from Italy, guns and firearms from anywhere.
Gold flowed out of the country. With their new credit, nothing was too expensive. Even today, a stroll through any regional Spanish town reveals churches, great houses, palaces and ornate fountains built by Italian architects and paid for with Latin American gold. By 1590, of all the goods shipped from Spain to its new colonies, 80 per cent had been imported from elsewhere in Europe.
(This was in direct contrast to the British Empire, for example, which shipped British-made goods from Britain to its colonies.)
Pretty soon, Spain forgot how to make things. Production of everything from food to clothes faltered.
As one observer at the time put it, ‘‘Agriculture laid down the plough, clothed herself in silk and softened her work-calloused hands. Trade put on a noble air . . .went out to parade up and down the streets.”
Apart from general idleness, another far more insidious enemy emerged to face the Spaniards. The Spanish rapidly went into debt with other nations, paying over good Spanish money for what, at the time, were called ‘‘puerilities’’ – bangles, cheap glassware, playing cards and the like. Prices in Spain began to rise.
However, the rise in prices was not due to any economic shift in the economy, but to the non-productive abundance of gold. This is the same story in Ireland. Our prices over the years rose because of too much credit.
As inflation took hold in Spain, those Spanish manufacturers who had still managed to trade found themselves becoming increasingly uncompetitive. Having been the richest nation in Europe, Spain experienced successive financial crises as it tried to pay for its gold-inspired extravagance.
Ireland is in the same position now:
small manufacturing can’t compete with our neighbours, particularly as Britain and the US are – logically – allowing their currencies to fall in the face of the new realities. We have decided to tie our currency to countries that are virtuous savers like Germany, while we are delinquent spenders. This makes no sense but, like the emperor with no clothes, no one in the Irish establishment is prepared to admit this fundamental financial folly. In the end, silly policies don’t hold.
Back in the 16th century, the Spanish tried to keep afloat, but they ran out of gold, as we will run out of credit. Ultimately, the Spanish Crown defaulted on its loans in 1557 and further defaults occurred in 1575, 1596,1607,1627, and 1647, leading to serious crises in major financial centres such as Antwerp, Genoa and Lyons, since they had been the prime financiers of the Spanish loans.
The same is likely to happen in the next decade as the US, Britain and of course Ireland realise that they can’t pay all the money back that they borrowed in the good times. Britain and the US are likely to try to generate inflation or seek some debt renegotiation either officially or by stealth.
Ireland, is locked into the euro, so we won’t experience inflation and, therefore, are likely to default on mortgages, credit card bills and other loans.
The big question for the world is whether the creditors – the middle classes of the emerging powers – will stand idly by and watch their investments debased. Remember that Spain fought desperate wars of expansion to mask its economic decline in the 16th century. Whatever about financial history, let’s hope military history doesn’t repeat itself too.