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D - 2: Secular Inflation topples Empire

Updated: Mar 26, 2021

Over the last few weeks we heard a lot about the role Spain played in shaping of Renaissance Europe. It was a dominant power in the Western Mediterranean, stopped the advance of the Ottoman Empire in Vienna in 1529 and Lepanto in 1571, led counter-reformation and checked the advance of Protestantism, built an Empire in the Americas and a trading network that span the globe. By 1650, Spain was a spent power however. The Dutch commanded the seas and the French dominated Europe. How did this happen? Was it because the Spanish Armada was defeated in 1588 or it lost the war against the Dutch?

Reconstruction of the Spanish Treasure Fleet

Spain declined as Europe’s superpower because it used inflation to finance its war efforts. By around 1500 AD, Europe had recovered from the devastating population loss during the Black Death in 1347 and economic activities resumed. Total population had dropped from 79 million to 70 million. By 1450 it was back to 83 and by 1500 to 91 million. This caused a certain amount of inflationary pressure since it took time to ready deserted fields again for agricultural production. Food prices started to increase.

The runaway inflation of 2% a year (we think this is the desired inflation rate today – think about this for a second!) started with the inflow of silver from Latin America. From zero it reached 60 tons in 1530 just when Spain launched its efforts to control the coast of North Africa and reached 200 million tons per year less than 20 years later. This rapid increase did not only create a huge new business opportunity for Genoa’s bankers, it also pushed prices. Most of the silver inflow was spent on consumption and not on productive investments. Military campaigns were expensive and usually did not result in new taxable revenue. As the supply of goods could not keep up with the growth of the monetary base, prices increased. Over the following 100 years price levels throughout Europe would increase by the factor 5 to 6. In other words, for the same amount of silver Spain could now only buy 20% of the military kit as in 1500 AD. It was an unstoppable downward spiral.

Annual Silver Inflow into Europe primarily from Latin America. The drawn line represent the production of the mines in Joachimsthal on today’s Czech-German border where the Joachimsthaler was minted, in short called Thaler or in English Dollar.

For a while, increased silver production could compensate for some loss in value. Annual silver import reached almost 350 tons per year by 1700 but in terms of purchasing power this was not more than Spain got in 1530. Increasing the production would not have been possible without treating the native population in Potosi like slaves or worse. Working there must have been hell on earth. In the end, all their sacrificed were for nothing. Spain went bust anyway.

Spain’s weakness became apparent in the 30 Years-War (1618 – 1648) which it started as the dominant European Power and ended as just one of several who could not dictate its will on the battlefield any longer. France had become the dominant land power and on the seas the Dutch overtaken Spain and Portugal. Spain’s sovereign debt stumbled from default to default taking with it the many Genovese bankers which had so much benefited.

The Potosi silver mines in today’s Bolivia

Whether Spain could actually have used the silver from Latin America to become a truly modern nation is an open question. We know that it was not tried. True innovation happened in the Netherlands and England where scarcity of funds and necessity became the driving engines for innovation in fleet technology, early industrialization and financial markets. The creation of our stock exchanges dates back to this period or the creation of the Bank of England. Spain’s rigid and hierarchical culture would probably not have been up to the challenge even when tried. The King and the Church ruled absolute and everything required their approval. Today a guarantee for stifling innovation. To harvest the results of creative destruction one needs a liberal economic framework and the rule of law. Spain had neither.

Inflation in the UK – could not find a table for Spain but the inflation was almost the same everywhere in Europe due to the free circulation of the new silver.

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