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Lending to the Borrower from Hell: Debt and Default in the Age of Philip II

  • Mauricio Drelichman
  • Hans‐Joachim Voth

Philip II of Spain accumulated debts of over 50% of GDP. He also failed to honor them four times. We ask what allowed the sovereign to borrow much while defaulting often. Earlier work emphasized either banker irrationality or the importance of sanctions, in line with Bulow and Rogoff (1989). Using a unique dataset on 438 lending contracts derived from the archives, we show that neither interpretation is supported by the evidence. What sustained lending was the ability of bankers to cut off Philip II’s access to smoothing services. Lenders contracted with the king in overlapping syndicates, effectively creating a network of bankers. We analyze the incentive structure that supported the cohesion of this bankers’ coalition, and examine how it survived across the biggest defaults in Philip’s reign. In particular, we argue that the effectiveness of lending moratoria was sustained through a ‘cheat-the-cheater’ mechanism, in the spirit of Kletzer and Wright (2000). Since the king needed to smooth his expenditure in the face of major revenue and spending shocks, the ability of bankers to cut him off from funding was sufficient to sustain cross-border lending.

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File URL: http://hdl.handle.net/10.1111/j.1468-0297.2011.02442.x
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Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 121 (2011)
Issue (Month): 557 (December)
Pages: 1205-1227

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Handle: RePEc:ecj:econjl:v:121:y:2011:i:557:p:1205-1227
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  1. James Conklin, 1998. "The Theory of Sovereign Debt and Spain under Philip II," Journal of Political Economy, University of Chicago Press, vol. 106(3), pages 483-513, June.
  2. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-97, December.
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  4. Flandreau, Marc & Flores, Juan H., 2009. "Bonds and Brands: Foundations of Sovereign Debt Markets, 1820–1830," The Journal of Economic History, Cambridge University Press, vol. 69(03), pages 646-684, September.
  5. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  6. Rose, Andrew K., 2005. "One reason countries pay their debts: renegotiation and international trade," Journal of Development Economics, Elsevier, vol. 77(1), pages 189-206, June.
  7. Fernandez, Raquel & Rosenthal, Robert W, 1990. "Strategic Models of Sovereign-Debt Renegotiations," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 331-49, July.
  8. Roland Bénabou, 2009. "Groupthink: Collective Delusions in Organizations and Markets," NBER Working Papers 14764, National Bureau of Economic Research, Inc.
  9. Kenneth M. Kletzer & Brian D. Wright, 2000. "Sovereign Debt as Intertemporal Barter," International Finance 0003004, EconWPA.
  10. Jeffrey D. Sachs, 1989. "Introduction to "Developing Country Debt and the World Economy"," NBER Chapters, in: Developing Country Debt and the World Economy, pages 1-34 National Bureau of Economic Research, Inc.
  11. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  12. Andrew Atkeson, 2010. "International lending with moral hazard and risk of repudiation," Levine's Working Paper Archive 200, David K. Levine.
  13. Bulow, J. & Rogoff, K., 1988. "Sovereign Debt: Is To Forgive To Forget?," Working papers 8813, Wisconsin Madison - Social Systems.
  14. Lvarez-Nogal, Carlos & Prados De La Escosura, Leandro, 2007. "The decline of Spain (1500 1850): conjectural estimates," European Review of Economic History, Cambridge University Press, vol. 11(03), pages 319-366, December.
  15. Mitchener, Kris James & Weidenmier, Marc D., 2010. "Supersanctions and sovereign debt repayment," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 19-36, February.
  16. Cole, Harold L. & Kehoe, Patrick J., 1995. "The role of institutions in reputation models of sovereign debt," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 45-64, February.
  17. Mauricio Drelichman & Joachim Voth, 2006. "The sustainable debts of Philip II: A reconstruction of Castile's fiscal position, 1566-1596," Economics Working Papers 1121, Department of Economics and Business, Universitat Pompeu Fabra, revised May 2009.
  18. Carlos Álvarez, 2003. "The Role Of Institutions To Solve Sovereing Debt Problems: The Spanish Monarchy´S Credit (1516-1665)," Working Papers in Economic History wh030804, Universidad Carlos III, Instituto Figuerola de Historia y Ciencias Sociales.
  19. Marc Flandreau & Clemens Jobst, 2005. "The Ties that Divide: A Network Analysis of the International Monetary System, 1890-1910," Sciences Po publications n°5129, Sciences Po.
  20. Mauricio Drelichman & Joachim Voth, 2011. "Serial defaults, serial profits: Returns to sovereign lending in Habsburg Spain, 1566-1600," Economics Working Papers 1262, Department of Economics and Business, Universitat Pompeu Fabra.
  21. Rui Pedro Esteves, 2007. "Quis custodiet quem? Sovereign Debt and Bondholders` Protection Before 1914," Economics Series Working Papers 323, University of Oxford, Department of Economics.
  22. Flandreau, Marc & Jobst, Clemens, 2005. "The Ties that Divide. A Network Analysis of the International Monetary System," CEPR Discussion Papers 5129, C.E.P.R. Discussion Papers.
  23. repec:spo:wpecon:info:hdl:2441/605 is not listed on IDEAS
  24. Drelichman, Mauricio, 2005. "The curse of Moctezuma: American silver and the Dutch disease," Explorations in Economic History, Elsevier, vol. 42(3), pages 349-380, July.
  25. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973, April.
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