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Spring Books

Democracy finds its roots in debt and war

by James Macdonald
Farrar, Straus and Giroux, 564 pages, $30

Reviewed by GERALD SMITH

The primary thesis of this book is straightforward, but prolonged, and can be stated as follows: First, the history of Western civilization has been determined by those nations who could dominate in times of warfare. Second, the nation that was able to dominate in times of war was the nation that in times of emergency could borrow funds to prosecute the wars in which they were involved.

Third, hence the need of national governments for some financial mechanism that would allow them to borrow money quickly and efficiently in times of emergency. Fourth, democracies had an innate advantage to borrow funds in times of emergencies because of the identity of borrowers and lenders. Fifth, the ultimate conclusion of this book is that democracies arose in the western world largely because of this financial/military advantage that democracies enjoyed over autocracies. Hence the title of this book: A Free Nation Deep in Debt: The Financial Roots of Democracy.

In order to prove this thesis, James Macdonald has explored the connection between public debt that had been brought about by wars and democracy in the broadest possible terms. As a result, this book is a sweeping history of how nations’ governments finance their wartime activities beginning with biblical times when Moses divides up the spoils of warfare between the warriors and the community, all the way to a thorough explanation of how in this country post-World War II government policies induced inflation. That inflation largely paid the bills for World War II by reducing the real value of U.S. Treasury savings bonds.

According to Macdonald, the earliest known government recourse to borrowing from citizen creditors was in the city-state of Venice in 1164. Rather than taxing the citizens, this money was raised on a voluntary basis from 12 wealthy families. However, just three years later in 1167, there was the first instance of a forced loan, which came to be the hallmark of Venetian and Italian borrowing throughout the Middle Ages. It probably should be noted that most of these loans were never repaid so, in effect, they became the taxes that the governments were initially attempting to avoid.

Next, the story of government citizen debt jumps to the Netherlands. This narrative of the 80-year war for the independence of the Dutch may be the most impressive example of the power of citizen creditors. The Dutch waged war from 1568 to 1648. By the end of the war, the Netherlands had transformed itself into an independent and extraordinarily wealthy republic. On the other side, this war led to ruin for the Spanish Empire.

How were the Dutch able to take on an empire of 20 million and win? The Dutch were fighting on their home territory in the cause of their own freedom, but according to Macdonald, this was not the only explanation. The Dutch also had to raise sums that could match those of Spain, sums that seemed almost unimaginable for a nation that numbered less than 1.5 million. The only way to approach the problem was to draw in full on the inherent financial advantages of a republic of merchants and borrow to the hilt, which is just what the Dutch were able to do. Macdonald credits this to the fact that the Netherlands was a republic while Spain was a monarchy.

The next act in this story moves to England versus France. However, the ending will be the same. The nation that financed its wars with citizen creditors would be the eventual winner. England had come to parliamentary rule through a long and involved path during the 16th, 17th and early part of the 18th century but by 1750 not only would its citizens be willing to contribute more in way of taxes, but they would also happily lend extra funds at low rates of interest, confident in the good faith of their government. As Macdonald notes: “In the century that followed [Napoleon’s] defeat, the financial principles of France’s great rival, England, reigned triumphant, and informed observers were inclined to the opinion that the advance of humankind must inevitably lead to the diffusion of parliamentary government and credit-based public finance.”

According to Macdonald, this state of affairs remained all the way to World War II. Once again, the nations at war borrowed from their citizens to finance the war. However, something new happened at the end of this war. After World War II, it became the official policy of the government that there would be no deflation, as there had been after every previous war, as the previous governments kept faith with the creditors. Instead there was inflation. As a result all the bondholders who had saved to finance World War II had their wealth eroded by this inflation.

Macdonald closes his narrative with the thesis that this result will have a large impact on any future wartime borrowing. Perhaps it will not be possible in the future for democracies to fund their wars by borrowing from citizens as it has been in the past.

Gerald Smith is professor of economics at Minnesota State University, Mankato, Minn.

National Catholic Reporter, February 7, 2003