Gelderblom O. & Jonker J. (2008) What really brought interests down

Gelderblom, Oscar & Joost Jonker (2009) “The Conditional Miracle. Institutional change, fiscal policy, bond markets and interest rates in Holland 1514-1713”, Utrecht University Working Papers.

Jan de Baen, Portret van Johan de WittOscar en JoostKaartLeiden

This paper is available online (pdf).

Traditional explanation of the low issuing rate on public debt in the Dutch Republic emphasize the dramatic fall that occurred around 1600, but fail to explain why this level kept on falling from 1640 to 1725, until it had reached 2.5% (p.2).

Borrowing trust

From 1482 to 1625, the province of Holland was not trusted by investors and had to access capital markets through the towns’ credit (p.3). The first issues of provincial debt occurred in 1540, however the bulk thereof  had to be forced upon the province’s municipalities (and through them, their wealthy citizens; p.4). These loans were repaid swiftly which built up confidence in the province creditworthiness (p.5).

But the Dutch Revolt proved too much to cope with for a system then still in its infancy and by 1572 the province had to suspend payment (p.6). The province’s credit was gradually restored but the issue of its debt on the annuities market still failed repeatedly well into the 1590s (p.7).

At the creditors’ mercy

A key element in the province attempt to restore confidence was its move away from annuities towards bonds, which offered investors higher returns and more liquidity. Higher demand allowed the authorities to bring interest rates on bonds down and to turn them into long-term financial instruments during the first decade of the 17th century  (p.8). The resumption of the war in 1621 increased significantly the province’s demand for money and, 1625, the Estate had to resort one last time to a loathed  forced loans (p.10).

Back to normal?

In the 1610s, the ratio of debt to tax barely approached 3, four decades later it had reached what the Estate apparently considered to be the limit: 12 (p.12). The bulk of this debt came from bonds; demand for annuities was sluggish and they were seldom traded on the secondary market. The Estate tried several times to consolidate (i.e. turning perpetual bonds into annuities) and diminish its debt after the Treaty of Westphalia (p.14).

These efforts were made totally vain by the 1672 invasion which forced the province to raise 10 million guilders on the free market plus 25 other millions in forced loans. The liquidity squeeze resulting from the various levies forced many to sell the annuities they had been holding on and brought prices down (consequently a new secondary market for annuities arose in Holland, p.15). Finally, the Estate had to resort to levying a new 1% tax on public debt interest payment (p.16).

A (long) conclusion

At long last, the Estate had managed to downsize its debt by the end of the 1680s (p.17). However war resumed and as the tax on bonds was increased to 2% in 1702, the price of that security quickly dropped by 25% (p.18). The market for 4% bonds was exhausted by 1710, the province had to resort to foreign investors and lottery tickets. By the time the treaty of Utrecht was signed, Holland debt had soared to 300 million guilders (twice the province’s GDP) inefficiently divided into a host of heterogeneous vehicles and it took 2/3 of the budget to service it.

The foundation of Holland’s financial success was a political regime change effected in the sixteenth century, in particular the establishment of provincial control over excises. Without the secular rise in tax revenues the Dutch government would never have been able to raise the funds necessary to secure Dutch independence. However, political and fiscal changes alone cannot explain the emergence of a free market for government bonds. The growth of the Dutch economy was an equally vital ingredient because it created a thriving private capital market and a class of wealth owners who played the private and public markets fully as calculating investors do, considering options, weighing alternatives, and trying to exact the right price. It was up to the government, however, to choose between taxing and borrowing from the new elite.

The province definitely departed from the coercive fashion of accessing capital markets only in 1625. Hence before this date, the so-called Dutch financial revolution had more in common with the Italian city-states than with the post-1688 England. Moreover this advance was not definitive as the authorities commonly considered resorting again to force loans (p.21). The twilight of the Golden Age and the fact that the government had exhausted every available fiscal expedient meant that the United Province had to withdraw from the central continental stage early in the 18th century (p.22).

Disclaimer: this summary is written by the contributors of the blog and not by the author of the article. Any mistake is Manuel’s fault (and he shall be punished). It should also be noted that this is a working paper and should be taken as such.

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