King Philip II’s Default of 1557

After wresting control of the gold and silver of the Americas, one would think that the 16th century would be prosperous for Spain and enriching for its monarch. It may very well have been but even this did not render the king’s creditworthiness invincible to all challenges. The century was one in which the Habsburg monarchs ruling Spain maintained an empire that included large parts of Europe and involved frequent wars, principally against France, that cost the monarch extraordinary sums. In 1557, both the kings of Spain and France suspended payments on their debts. Yet, Spain would be able to borrow, and default, a few times more in the remainder of the century.

16th Century Trends

Far from a stagnant era, there were several noteworthy financial trends in Europe in the 16th century. One of the more significant was a monetary one. While the 15th century was known for a shortage of precious metals, causing the economy to become partially demonetized, there were growing amounts of silver in circulation after the discovery of the Americas. Besides silver, there had been imports of gold from Africa and America as well, but gold was being hoarded rather than used in trade.

The silver that was being used in exchange came from both Europe and abroad. Silver was being mined in Germany, Austria, and Bohemia. This output peaked in the 1530s. Silver also came from Potosí in Peru after the Central European production had peaked. The American silver benefited the Spanish Habsburg monarchs who ruled not just Spain and its colonies overseas but also large parts of Europe, such as the Netherlands and parts of Italy. Since precious metals tended to leave their domains fairly quickly through trade, all over Europe the growing money supply, together with population growth in excess of agricultural output, led to inflation.

Europe was becoming more financially integrated in the 16th century. Notwithstanding the continued importance of the Mediterranean, Northern Europe became more crucial in trade. Leading financial centers shifted northward as Bruges started out the century particularly relevant and Antwerp grew in importance thereafter. However, Italians were still dominant in finance and Southern European cities were also commercially relevant, including one outside Italy, namely Seville, then one of the most important financial centers in Europe. In any case, all of these cities were home to many foreign merchants and financiers.

Cities replaced medieval fairs which were losing their relevance in trade. The old fairs still had some importance as settlement venues for bankers though. Whether in fairs or cities, in the 16th century, financial practices became more advanced and many new banking fortunes were created. One of these was that of the Fuggers, perhaps the most prominent banking dynasty of the era. They were German bankers in a period when Germans, especially those from southern Germany, learned from practices established in Northern Italy and disseminated them further.

The 16th century was also one of numerous wars, many of them associated with the Protestant Reformation or the rivalry between the Spanish Habsburgs and the Valois dynasty ruling in France. During Philip II’s reign of forty-two years as King of Spain in the second half of the century, the country was at peace for just six months. War spending constituted a large expense for almost all kingdoms and comprised as much as 90% of the Spanish monarch’s spending in some periods. While fighting came and went, wars could be very long, and this posed a massive financial challenge. State income might be stable, but war spending could grow quickly, requiring large amounts of borrowing by Europe’s nascent nation-states.

Portrait of Philip II by Sofonisba Anguissola

Spanish Debts

Lending to the Spanish monarch might seem enticing. Besides taxes levied on Spain itself, a fairly considerably sized kingdom, Spain collected a 20% tax on precious metal imports from its American colonies. This revenue source could be more volatile but no other kingdom had an equivalent windfall to tax. Then there was the income generated by Spanish territories in Europe, most notably the Netherlands. Indemnities in war also augmented the royal income from time to time. For example, Emperor Charles V captured King Francis I of France at the Battle of Pavia and released him in exchange for four of his sons kept as hostages until they were later released for 2.29 million escudos.

Adding to their creditworthiness, the Spanish monarchs also generally kept their currency intact, refraining from the debasement of coins other kingdoms resorted to regularly. Still, the Spanish monarchy borrowed a lot of money in the reigns of Charles V and Philip II. Wars were not the only expense, Charles V borrowed 850,000 florins to bribe electors allowing him to be elected Holy Roman Emperor. But wars were the principal driver of borrowing. Money was being spent in wars against France, the Turks, and the Protestant German Schmalkaldic League. These wars were fought not with regular Spanish troops but with expensive mercenaries, mercenaries that would accept nothing as payment other than precious metals.

Spain borrowed this money by issuance of juros, which were long term perpetual bonds backed by specific recurring tax revenues, and asientos, which were short-term loans lent against the general credit of the monarch. The former had interest rates of around 7% in this period. The latter were often arranged on an ad-hoc basis, often directly between field commanders and bankers on the front and their terms varied. The monarchs also leveraged the credit of cities; money was borrowed by Dutch towns and provinces for use by the king.

Charles V was borrowing money from the Fuggers and from other German and Italian bankers, generally in the form of asientos. In exchange for making an ad-hoc loan, lenders earned not only interest but also received the right to export precious metal from Spain. These bankers also assisted the monarchy by transferring funds from Spain to the Spanish Netherlands. There, money was spent to employ mercenaries fighting the French.

1557

The long wars of the 16th century often achieved little for the money spent on the fighting. Over 2.5 million ducats were spent on the siege of Metz alone and this resulted in a defeat for Charles V, who failed to take the city in 1552. A truce between France and Spain came in early 1556 and that year, Charles V abdicated in Spain in favor of Philip II.

The financial situation Philip II inherited was a mess. Also in 1556, a request by Philip II for more money from his Dutch subjects, in the form of a tax on both real estate and movable property, was rejected by the provincial governments there. There was a drought and bad harvest that year in the Netherlands, though the Dutch agreed to a smaller subsidy to their king to be payable the following year. It was not enough. Making matters worse, Philip II continued the wars with France in early 1557 and would borrow even more.

Philip II suspended payments on the debt and resorted to confiscating silver imports in 1557. Spain was not the only bankrupt European country in 1557. That year, his adversary Henri II of France also failed to make necessary payments on his debts. Europe’s two leading powers had bankrupted themselves fighting each other. In France, redemptions of debt were suspended, and interest was unpaid and added to the principal of the debt. These claims were also depreciating as the market value of French debts fell to 70% of face value.

Consequences for Bankers

At the time of the 1557 default, most of the lending to Spain was done by German bankers and most of the debt accumulated before Philip II took the throne. The Fuggers were doubly exposed; they had lent a lot of money to the Spanish monarchs and also had a lot invested in Spain. As in Germany, they owned mines there, such as mercury mines at Almadén. The money lent by the Fuggers was itself borrowed from the Catholic Church and in financial centers like Antwerp. Needless to say, the Spanish default meaningfully impaired their fortunes.

While German bankers continued to lend to the Spanish after the default, Genoese bankers came to take their place as the most prominent new creditors to the Spanish monarchy. The Genoese were not unaffected by the Spanish default, but they settled their debts with the state early while others, including German bankers, held out longer and for little since they ultimately settled for less favorable terms anyway. The Genoese were able to halt money transfers for the Spanish after the default, encouraging the king to settle his debts or else face military setbacks. Creditors also increased their power by forming coalitions amongst themselves whereby members would agree not to lend Spain any more money until they settled past debts, protecting lenders.

After the restructuring, Genoese bankers became the favored bankers of the king. They were responsible for making loans to the monarch and placing Spanish juros with investors. In exchange for purchasing asientos they received juros as collateral that they could sell to repay their loan. Still, this did not make lending to the country that had already defaulted on its debts a safe venture. In the years after the restructuring, rates on asientos were typically above 15%.

Spain would default on its debts four times during the reign of Philip II. After 1557, the next one came soon, in 1560. Despite this, Spain was not cut off from bankers’ capital; its debt still grew over the course of the 16th century. The reason was that lenders were rewarded for their patience and risk tolerance. Returns to sovereign lending in the reign of Philip II depends on certain assumptions used but was nonetheless very profitable, almost certainly in excess of 10% per year.

Lesson

The capacity to take on debts can often outpace the income to service that debt. No country, or individual or company for that matter, is so prosperous that it cannot become overindebted. The example of 16th century Spain is a near perfect example. Its ruling dynasty was the most powerful in Europe, it could mint what across Europe was readily accepted as money, and yet it would have to suspend payment on its debts four times in half a century. However, the cost of a default for such a large debtor seems different than for a small one, such as an individual or company. Spain was not cut off from credit after these suspensions and for all its trouble, it was still a leading power going into the following century.

More from the Tontine Coffee-House

Read about the Fuggers and the 16th century financial contributions of Sir Thomas Gresham. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.