By Harris Kupperman
In 1492, Queen Isabella turned a small speculation into one of the greatest investment decisions of all time. Following early exploratory voyages to the New World, bands of bloodthirsty Spanish marauders arrived, conquered empires, and began exporting gold back to Spain. Seemingly overnight, Spain went from backwater to the wealthiest nation in Europe. Of course, the Spanish tried setting up a colonial administration to monitor and diversify the revenue streams, but with the lure of gold, most administrators deserted their posts in search of wealth. As long as Spain was collecting a healthy tax on the gold coming into the mother country, the crown was indifferent to what transgressed in the colonies.
With all the gold flowing into Spain, you would assume that it could capitalize on its wealth—this was not to be the case. Freshly-arriving millionaires from the New World discouraged the creation of industry. Why work for decades and build up a business, when you can just steal all you want from the natives? Why tend a farm or flock of sheep and earn ten percent on your capital, when there was unlimited wealth on the other side of the ocean? Farms became overgrown with weeds, livestock perished, cottage industries wilted, and innovation ceased.
The notion of thrift vanished. Those who became wealthy overnight spent it just as fast. Often they were forced to return to the New World for another round of plunder. The real winners were the Venetian merchants who supplied luxury goods from the Orient and the French. The Renaissance could not have taken hold without the abundant wealth created by Spanish gold flowing into the Mediterranean region.
Prior to the arrival of copious amounts of gold and silver in the early sixteenth century, silver was reserved for large payments and taxes, while most transactions were done using barter and coins made of base metals. Gold was reserved almost exclusively to transact much larger purchases between the nobles. When the torrent of precious metal arrived, a slow and pervasive inflation took hold of Spain. While the poor suffered, the wealthy, who financed the overseas ventures, had massive profits and felt significantly better off. They were largely indifferent to slightly higher prices—especially because the wealthy chose to buy most everyday goods from the French using their incredibly strong gold currency. In France, the inflation took much longer to take hold and French manufacturing grew up all along the Spanish border. The French in turn were able to purchase most raw materials, including labor, at much-reduced prices from areas even further removed from Spain’s gold induced inflation. In this way, a creeping inflation slowly spread out over all of Europe, eventually even penetrating the eastern portions of Europe by the seventeenth century. We now export our inflation to the rest of the world as a result of our Federal Reserve printing too much money. It took over a decade, but inflation is now showing up in far- flung corners of the globe where it shouldn’t be expected.
Surprisingly, no one was concerned about the gradual hollowing out of Spanish production. No one worried that the poor were increasingly unable to afford the necessities of life. No one was concerned about the massive current account deficits that Spain was running with the rest of the world. No one cared that these deficits were financing the military buildup of Spain’s enemies. No one even seemed to notice the debt that Spain increasingly was building up. The prevailing view amongst all sectors of society was that the answer to all problems was adventuring to the New World and seizing precious metals. As the above ground stocks were rapidly depleted, the Spanish used Indian labor to mine very high grade veins near the surface. For the Spanish, the New World became the equivalent of the Federal Reserve’s printing press—the solution to all problems. However, things began to slowly turn for the Spanish. Precious metal shipments peaked in mid-century and by the late sixteenth century, the annual gold shipments began to decline—only to disappear almost all together by 1610. By 1630, even silver shipments went into a tailspin. As the ready source of purchasing power fell off, Spanish citizens refused to change their ways. To finance their lifestyle, they borrowed from abroad. At this time, the monarchy held considerable sway in all business affairs. It is estimated that around half of all economic activity was conducted for the account of the king. No one borrowed more from abroad than Charles V and his son Philip II.
Charles ascended the throne in 1516. With the newly-acquired wealth, he engaged in decades of intermittent warfare with France and then the Netherlands. Responding to the Pope, he took it upon himself to be the world’s policeman against the Protestants. He even financed wars against the Turks. None of these expenses directly benefited the Spanish, yet with all the wealth available to the crown, and hordes of eager lenders, there was no problem with financing these adventures. I find it analogous to our own stupendous spending on a military stationed in almost a hundred foreign countries, trying to achieve all nature of dubious tasks like democratizing the Middle East.
As long as Spain could find financiers, all was good. Eventually, the bankers realized that they were stuck. They could only receive their interest payments by lending Spain more capital. Meanwhile the collateral, the annual gold shipments, were rapidly dwindling. At first the bankers dawdled, finally they cut their losses, and Spain convulsed in a series of financial crises that saw mercenaries mutiny for lack of pay. Throughout this mess, there was a lot of finger pointing but nobody was willing to take the hard steps necessary to fix the problems. Repeated inquisitions were launched as scapegoats were sought. Trying to live within one’s means was seen as simply too difficult a task for a nation now accustomed to better living. Spain did not immediately collapse. It took multiple centuries of slow decline before Spain became irrelevant.
I find an uncanny resemblance between Spain’s slide from empire and our own situation. Over the past two decades, we’ve increasingly relied on cheap credit and money creation to finance both economic growth and a lifestyle that is beyond our means. When there is a problem, the easiest solution is to lower interest rates and add liquidity to the system. This is similar to Spain’s solution—send a larger flotilla to the New World and export more treasure. In the short run, this is a perfect fix. The downside is that it does not allow for the underlying issues to resolve themselves. Much like Spain, we’ve hollowed out our manufacturing base in this country and now increasingly rely on foreign production for many basic necessities. As long as this can be financed, there are no issues. At some point, our bankers in Asia will finally decide that we will never repay our debts and they will refuse to lend us any more.
Not only are the structural conditions troubling, but even more importantly, our population has taken on a casino mentality when dealing with everyday life. The Spanish ventured to the New World, struck it rich and returned to spend in the mother country. In America, we participate in Ponzi schemes, hoping to somehow get out before it all collapses. First we had a stock bubble, then a housing bubble. Some made their fortunes but instead of saving, they spent it on baubles with the confidence that they could speculate on something else and earn money again. Our Federal Reserve has, for some unknown reason, facilitated this. Our politicians spend with reckless abandon. Rooting out Muslims in Iraq makes about as much sense as Philip’s campaign against Lutherans in the Netherlands. Meanwhile, no one notices that the average American falls further behind a slowly creeping inflation. For now, there are only murmurs. As long as Capital One and MBNA finance this lifestyle, there cannot be a crisis, but I wonder how much longer the Asians will buy our debt securitizations. How much longer will they buy our government’s debt? How much longer can we subsist as a nation of speculators?
When I was at the annual Berkshire Hathaway meeting, Charlie Munger said something to the effect of, “If we all work at hedge funds, what will we do for food?” I think this sums up the current predicament in this country. Many of us are engaged in practices which do little for the nation’s betterment. In the short run, they seem lucrative to the individuals, but from a top down view, I am not sure our country is better off as a result of these activities. Even worse, our government tries to cheer on these practices. At some point, there will be a price to pay.