Econ Addicts

“Debt, like rust, never sleeps.”
– Thomas Jefferson

Government debt. You’re probably thinking of that insane US debt clock with the 36 trillion dollar sum (and counting) that the United States owes to its lenders, but have you ever thought about how a nations’ ability to borrow huge amounts of cash even began?

How did nations begin using debt and financing to fund governmental operations?

Public debt as we know it finds its roots in Europe’s early history, around the time that tribes who occupied territories were becoming kings forging empires. Although debt as a concept had existed for millennia beforehand, “borrowing by monarchs and states traces back at least a thousand years, to the period following the fall of the Carolingian empire, of Franks and Lombards who ruled much of Europe in the first millennium CE” (Esteves, El-Ganainy, Mitchener, and Eichengreen 2). Towards the end of this era, Europe had split into dozens of city-states and kingdoms. This geopolitical fragmentation ignited fierce disputes that spiraled into prolonged wars and relentless periods of conflict that ravaged nations for centuries. Polities were often caught fighting battles on multiple fronts simultaneously, and each engagement demanded surpluses of supplies, weaponry and soldiers. In the midst of wartime, when a state or nation was quickly expending resources, a lot of times, war costs exceeded GDP.

This is where the public debt comes in.

Military campaigns were and still are incredibly expensive and resource-depleting, and the survival of a nation depends on its ability to wage war. Acquiring large-scale financing of weapons, supplies, and man-power requires money. Prominent Italian banking families like the Medici’s vied to extend their influence during this era by lending to sovereign leaders. They had to craft intricate and strategic contracts to maximize the assurance of repayment, as loan repayment was anything but guaranteed.
Lenders faced huge downsides which created an inherent need to secure repayment on their loans. If you think about it too much, you might wonder, “Why even bother lending in the first place? You’re handing money to immensely powerful heads of state who have little incentive to repay you and all the protection they need to avoid retaliation, given they command entire armies.” It’s a daunting challenge. Yet, the demand for financing the ambitions and problems of growing nations never fades. Should a head of state default on an agreement, they risk tarnishing their reputation as a reliable borrower—potentially cutting off future funding, crippling their operations, and potentially leading to their downfall.

So, lenders got creative. New, pertinent technology is costly and ever improving – requiring financing. Maintaining trade routes and ports is expensive – requiring more financing. Maintaining and expanding the public infrastructure of territory is a massive cost burden – requiring even more financing. Therefore, access to financing is imperative to the continuation of the state. Political leaders also had to get creative in the ways they imposed taxes on their people. Lenders got their hands in this process by monitoring tax collections and in some cases, raising taxes directly themselves. Still, large risks still remained, and lenders had to diversity or suffer the consequences. “They securitized their loans and organized secondary markets on which government bonds could be traded” (Esteves, El-Ganainy, Mitchener, and Eichengreen 2).

Government Bonds – Gamechanger.

Secondary bond markets allowed foreign investors to purchase a nation’s debt, which diversified the risk for lenders and expanded the pool of potential buyers. The increased access to capital lowered borrowing costs for the country, while the ability to trade bonds enhanced liquidity. It also enabled countries to tap into foreign capital, making it easier to finance projects and manage budget deficits. How though? By a simple and fundamental principle: the more investors involved in any given entity, the greater the collective interest in its growth and sustainability. This applies even when that entity is an entire nation. This new development aligned the personal interests of investors with those of lenders, prompting both groups to seek greater protections and securitization for their investments. England and the Netherlands are the pioneers of this implementation. “They established legislatures and parliaments, in which creditors were represented, to advise and consent to the state’s fiscal policies” (Esteves, El-Ganainy, Mitchener, and Eichengreen 3). With checks and balances, lenders were able to lower interest rates, since their loans were now almost certain to be repaid. Ultimately, borrowing became more accessible and widespread.

As the frequency of interstate conflicts in Europe decreased with the development of public debt markets, the constant threat of war gradually lessened, which paved the way for sovereign nations to form. The lending securitization provided by governmental checks and balances paved the way for the development of other securitized public capital markets, such as stock markets.