Working Paper: CEPR ID: DP7276
Authors: Mauricio Drelichman; Hans-Joachim Voth
Abstract: Philip II of Spain accumulated debts equivalent to 60% 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. Using new archival data, 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. We analyze the incentive structure that supported the cohesion of this bankers' coalition. Lending moratoria were sustained through a "cheat the cheater" mechanism (Kletzer and Wright, 2000).
Keywords: Early Modern State Finances; Incentive Compatibility; Philip II; Serial Default; Sovereign Debt; State Capacity
JEL Codes: F21; F34; N23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| coalition of Genoese bankers (P13) | sustained lending to Philip II (F34) |
| coalition's cohesion (D74) | sustained lending to Philip II (F34) |
| cheat the cheater mechanism (C72) | sustained lending to Philip II (F34) |
| king's military needs (H56) | negotiation with coalition (D74) |
| cross-posted collateral and agency relationships (G24) | difficulty for Philip II to selectively default (E49) |
| reputation and market power of lenders (G21) | sustained lending to Philip II (F34) |