James MacDonald, A Free Nation Deep In Debt

There is a book I have been meaning to write a bit about for a long time now. It is James MacDonald, A Free Nation Deep in Debt: The Financial Roots of Democracy (FSG 2003).

I picked up this book when it was published in 2003, but then left it behind when I went on sabbatical to Spain shortly after, as it runs 500 pages in hardback. So I didn't read it until earlier this year, in 2005, and I was very glad I did. Here is the publisher's weekly summary:

Public borrowing from citizens in times of war has gone hand in hand with modern democracy, Macdonald argues in this dense, sweeping economic history. A former investment banker now living in London, Macdonald traces the history of public financing of "national emergencies" (read: wars), from the biblical era through the present day. Until modern times, he shows, nations relied on stored treasure and surpluses to finance wars, often with detrimental results. Indeed, Macdonald argues that an inability to raise taxes for wars was one of the causes of Rome's downfall. Placing the importance of credit back at the center of historical causality is one of the book's strengths. The system of public credit swept onto the world stage in 18th-century Britain, France and the United States, and was intricately linked, notes the author, with revolutions in these latter two countries. During the 20th century, the system-and the notion of a "citizen-creditor"-reached its strongest point during WWI and likely had its swan song during WWII, because of postwar inflation, the succeeding decline in trust in government in the West and the increasingly global understanding of citizenship. There is much to learn here, but despite Macdonald's best attempts at accessibility, readers without a background in economics will struggle through.

That's a pretty accurate summary, although the most powerful part of the book, I think, is the discussion of the rise of public finance and the links to democracy and absolutism beginning with the Italian city-states, and going on to early modern France and Britain and Holland. (In some important ways, it recalls Niall Ferguson, before he decided to become a pundit, in Ferguson's history of First World War finance, The Pity of War.)

The essential thesis is that states which were able to persuade their own citizens to purchase the sovereign's bonds tended to be more democratic, because they had to be responsive to citizens in order to persuade them to become their own state's creditors. Contrawise, absolutist states, such as France of the Sun King, had could not persuade their own citizens to finance the king's wars voluntarily and, because no state's treasury was large enough to absorb more than the first campaign in war, had to look to foreign bankers to finance the debt - but because they correctly feared the repudiation of debts, charged interest rates accordingly.

MacDonald, whose historical reading is wide and deep, quotes - of all things - the memoirs of the Duc de Saint Simon on the French King, not merely the famous passage, "he loved war too much," but a much more subtle passage about the relationship of absolutism to debt:

"An establishment of this sort [John Law's famous state bank proposal] may be good in itself; but it is only so in a republic or a monarchy like England, whose financed are controlled by those alone who furnish them, and who only furnish as much as they please. But in a State which is weak, changeable, and absolute, like France, stability must necessarily be wanting ..." (at 193, emphasis added)

As MacDonald observes, it is the "juxtaposition of the adjectives 'weak' and 'absolute' that catches the eye ... Saint-Simon recognised, for perhaps the first time in European history, the inherent weakness of an absolute monarchy and the greater inherent strength of a republic of merchants." (at 193) At another point in the book, someone argues that in a military struggle defined by access to capital, the English will inevitably do better than the French, because they can gain loans from their own people at 3-5% interest, while the French king must pay two or three times that.

The entire book is filled with this richness of historical detail coupled with the detailed knowledge of finance that a former investment banker is able to bear. The very title comes from an 18th century anonymous English pamphlet praising (however strange to our contemporary ears) sovereign debt as being the way in which government is held in check and liberties maintained.

Yet MacDonald is very careful to point out the profound limits of the argument. He notes that by the twentieth century, the fact that debt was not widely held among the whole population - the republic was not, so to speak, a republic of merchants any longer, even though merchants held the debt - meant that different classes and groups in society had different interests. The merchants sought a state that would repay their loans with interest, while others in society who did not hold sovereign debt - not merely the poor, but also, in the case of England, the cash poor landed gentry - had in mind quite different tasks for the state and fisc. MacDonald's thesis extends to an important historical factor in the establishing of the Western democratic state, but he does not suggest that the role of sovereign debt has not changed enormously over the centuries.

I really do think this is one of the best books on the history of finance set in a broader political setting that I have ever read, and I would have thought it should have been considered one of the best books in history for 2003.