Deflation Made Simple (Part II)
The Story of Real Money (Entry 117)
Recovering from the rampjaar (Image 97, Entries 115-116) was not an easy task for The Estates of Holland. Nearly everyone had his own disaster from which to find relief, and lending money to the state was only a priority for The Estates — few others.
In the overall scheme of things, it was one thing to have stood united against the authoritarian Catholic rule of Louis XIV; it was quite another to support the new royal stadtholder who saved the nation while blaming the republican Johan de Witt (Images 97, 99, 100, and 103 and Entries 113 and 115) for The Estates’ near demise. What is more, the urgency of defense had dissipated with the Peace of Nijmegen (1678-79), and many were still in need of liquidity. The prewar fear and wartime concern that led to an increase in the demand for liquidity may have dissipated, but the demand for liquidity had not. Recovering from the destruction of war was costly, and the demand for liquidity remained unabated. Money-in-use was converted into money-in-exchange.
Accordingly, the demand for bond redemption was no less greater after the war than it was just before it, The Estates’ debt load was now much higher, and The Estates’ ability to service this load was now more strained. In effect, The Estates were faced with an important financial dilemma. Although a profitable enterprise for arms producers, their suppliers, and those awarded military promotions, war is generally a costly endeavor for nearly everyone else. For the Dutch in particular, what part of the war was not fought at sea where the Dutch prevailed, was fought almost entirely on Dutch soil!
Not only had the Dutch to recover from the property damage brought about by foreign occupation and the warring that resulted, but also by the shortage of breadwinners who had fallen or were maimed in war. In addition, what spared Amsterdam from destruction was paid for by everyone who owned property in the land inundated by ocean water when the dykes were breached to stop the French advance. Entire villages and towns were wiped out — damage far greater than the pillaging that often accompanies invading troops.
Alas, what united the Dutch in war against the pending authoritarian Catholic rule of Louis XIV, was diminished in the war’s aftermath.
Within the span of several years the political pendulum had swung in the United Dutch Provinces from a republic fighting for its existence against authoritarian Catholic rule — first the Spanish Crown and now the French — to a republic threatened from within by a royalist takeover imposed by the House of Orange (Images 79, 80, and 99, and Entry 116). Yes, to his credit, William III remained loyal to the Calvinist tradition of the Dutch people, and yes, his grandfather William I (Image 79) had played an important role in the formation of the United Provinces in 1579 (Images 80 and 84) and their subsequent abjuration of the Spanish Crown in 1581 (Image 84). This said, most Dutch did not appear interested in the establishment of a constitutional monarchy similar to that evolving on the British Isles.
Still, the The Estates had to service their debt, if they wished to retain their credit-worthiness at home and on the world stage. What worked well during the war — namely, the imposition of forced loans — was no longer appropriate as the emergency was over. Then too, how could one raise taxes in an economy recovering from war and still enjoy the support of the people? The Estates were shrewd, and they invented what appears to be the world’s first withholding tax!
No, this was not a payroll or a social security tax like we have in modern America. Indeed, the Dutch understood that it was one thing to tax the hand that sold the milk; it was quite another to tax the hand that fed the calf that became the cow that produced the milk. In the first instance, one taxes what has already been produced; in the second instance, one taxes the source of production even before anything has been produced! Even The Estates understood that the state is just another form of consumption, and that before one starts taxing one’s citizens, one must first make certain that they have something to consume!
So, the tax was placed on the interest income of The Estates’ outstanding debt. In this way, The Estates honored their commitment and paid their interest due. Simply, as the interest was being paid, The Estates withheld a portion of what it paid out, as it was being paid. It was a tax on the wealthy, but it was a tax on money-ad-prodigo, not on money-in-use per se. It was not a tax on production.
The result, of course, was to diminish the rate-of-return on money-generating debt instruments and encourage those who held them to want to want to redeem them all the more. After all, there were other investment opportunities that were not taxed and offered a higher ROR! Still, The Estates held their ground. Although it could no longer justify forced lending, it continued to refuse bond redemption. For The Estates it was a matter of life or death. Fortunately, for The Estates there was no dearth of Dutch financial creativity.
So, the now fully formed secondary bond market continued to flourish, and The Estates introduced a variety of new debt instruments. We will consider these new instruments next time with a closer examination of the bond market overall.
In liberty, or not at all,
Roddy A. Stegemann, First Hill, Seattle 98104