Deflation Made Simple (Part II)

A falsely vilified phenomenon (Entry 115)

Under the responsible stewardship (1653 until 1672) of Johan de Witt, the Grand Pensionary (raadpensionaris) of the Province of Holland (Images 99 and 100), the debt-to-tax ratio of The Estates of Holland decreased from a high of 12.5-to-1 just after the close of the 1st Anglo-Dutch War to a low of 11-to-1. This decline was achieved by both an increase in taxes and a decrease in outstanding debt from 131,435,779 Guilders in 1652 when the war broke out to 128,397,000 Guilders on the eve of the Anglo-French invasion in 1670 — an overall decline of about 2.3 percent. During this same period the overall debt had peaked at 131,973,716.

From 1672, the Year of Devastation (rampjaar), until 1679 The Estates‘ debt burden grew steadily from its low of 128,397,000 Guilders in 1670 to a new high of 161,883,000 Guilders in 1679. The war had been very costly and The Estates needed time to recover. Still, Johan de Witt’s budgetary legacy remained strong within The Estates, and eventually they were able to bring their budget under control. During the decade that followed — from 1679 until William III’s ascension to the British thrown in 1689 — the outstanding debt of the province of Holland decreased steadily to a new, but higher low of 159,196,000 Guilder — a 1.65 percent decrease, but still 2.4 percent higher than the 1670 pre-invasion level.

During this same period the debt-to-tax ratio decreased to about 9-to-1. Indeed, the Province of Holland was now the highest taxed province among the seven United Provinces and was reputed to be the highest taxed political entity on the continent of Europe. It was also Europe’s wealthiest entity and premier creditor.

In 1672 The Estates’ annuities and obligatie were trading at the same rate of interest — just over 4 percent. In the wake of the invasion the interest rate on the newly issued annuities rapidly increased to well over 5 percent, while the rate of interest on the obligatie declined. This phenomenon can be explained, in part, by the roll-over fee placed on outstanding debt instruments. After all, the revenue receivers had to earn a living too, and the amount of outstanding debt had increased by 2.4 percent from its prewar low (see above). Servicing interest on the outstanding debt had become more burdensome.

Not only was money scarce — everyone wanted more liquidity — and difficult to raise, but Hollanders were cashing in their debt upon maturity without renewal. In other words, The Estates’ treasury was being drained when it needed money most. So, a wealth tax was imposed, but it proved difficult to collect.

As a result, the The Estates decided to freeze all redemption and imposed forced lending — an interesting hybrid of money-per-vim and money-ad-prodigo — a kind of recoverable tax with interest. The redemption freeze stopped the drain on the treasury, and allowed The Estates to continue servicing their debt. This reassured its creditors that further lending would be rewarded so long as they remained patient. Indeed, there was a war, and the message was clear — victory and redemption, or defeat and default. Once everyone understood, Holland’s investors even began buying government debt voluntarily in support of the war. Whereas 25 million Guilders were raised in coerced debt issues, an additional 10 million were raised through the purchase of voluntary debt. This said, much of this debt was purchased with real estate and publicly traded private securities that good then be sold by The Estates to those with sufficient liquidity. Alas, money-in-exchange was still key; the Wisselbank remained rock solid!

The government had surely imposed, but it had not cheat!

And now, for the moment that we have waited for so long. Surely, you have not forgotten the story of Hendrik and his broker (Image 74)? It took some twenty plus years, but the market for the obligatie finally took off. There was a provincial-wide shortage of liquidity!

Selling a fixed rate debt-instrument below its principal meant immediate liquidity for the seller, and a higher than average rate-of-return (yield) for the buyer. Those with ample liquidity and confident that the Dutch provinces would prevail were eager to purchase the securities that The Estates were no longer willing to redeem. The Exchange in Amsterdam had never been a busier place!

In liberty, or not at all,
Roddy A. Stegemann