Financial History of The Dutch Republic - Collapse of The System

Collapse of The System

Though the 18th century has often been depicted as an age of decline of the Dutch economy, the picture is more nuanced. It is true that the "real" economy of trade and industry (and initially agriculture also, though there was a resurgence later in the century) went into at least relative decline, compared to neighboring countries. But it has to be admitted that those neighboring countries had to make up a big lag, which they actually only accomplished toward the end of the 18th century, when British per-capita GNP finally overtook the Dutch per-capita GNP. Meanwhile, within the Dutch economy there was a decided shift toward the "service" sector (as the British economy would experience a century or so later), especially the financial sector. Nowadays we would consider that a sign of the "maturity" of the Dutch economy at the time.

At the time (and by later historians with an ax to grind) this shift was often evaluated negatively. Making money from money, instead of from toil in trade or industry was seen as a lazy-bones' pursuit. The "periwig-era" has become a byword for fecklessness in Dutch historiography. The 18th-century investors are seen as shunning risk by their overreliance on "safe" investments in sovereign debt (though those proved extremely risky from hindsight), while on the other hand they are excoriated for their predilection for speculative pursuits. But do those criticisms hold up under closer scrutiny?

First of all it has to be admitted that many modern economies would kill for a financial sector like the Dutch one of the 18th century, and for a government of such fiscal probity. In many respects the Dutch were unwittingly just ahead of their time. Their "speculative pursuits" are now seen as a necessary and integral part of commodity and financial markets, which perform a useful function in cushioning external shocks. It is as well that the Dutch performed that function for the wider European economy.

It is true, however, that the way the 18th-century financial sector worked had its drawbacks in practice. A very important one was the detrimental effect the large Dutch public debt after 1713 had on the distribution of income. Through its sheer size and the attendant size of the necessary debt service, which absorbed most of the tax revenue, it also cramped the discretionary spending possibilities of the government, forcing a long period of austerity on it, with its attendant "Keynesian" negative effect on the "real" economy. The structurally depressed economy this caused made investment in trade and industry unattractive, which reinforced the vicious circle leading to more foreign direct investment.

In itself such foreign investment is not seen as a bad thing nowadays. At least it engenders a foreign-income stream that helps the balance of payments of a country (though it also helped keep the Dutch guilder "hard" in a time when exports were already hindered by high real-wage costs). Unfortunately, the signals the market for foreign investments sent to Dutch investors were misleading: the very high risk of most foreign sovereign debt was insufficiently clear. This allowed foreign governments to exploit Dutch investors, first by paying interest rates that were far too low in hindsight (there was only a slight agio for foreign bonds), and finally by defaulting on the principal in the era of the Napoleonic Wars. As John Maynard Keynes has remarked: after the default of foreign borrowers the lending country has nothing, while after a domestic default the country has at least the physical stock that was bought with the loan. The Dutch were to experience this vividly after 1810.

In any case, the periwigged investors had in certain respects no choice when they shifted to acceptance credit and commission trade, for instance. This can be seen as a rational "second best" strategy when British, French and Spanish protectionism closed markets to the Dutch, and they lacked the military means to force retraction of protectionist measures (as they had often been able to do in the 17th century). Also, apart from protectionism, the old comparative advantage in trade simply disappeared when foreign competitors imitated the technological innovations that had given the Dutch a competitive advantage in shipping and industry, and it turned into a disadvantage when the Dutch real-wage level remained stubbornly high after the break in the upward secular trend in price levels after 1670.

From this perspective (and from hindsight by comparison with other "maturing" economies) the growth of the financial sector, absolutely and relative to other sectors of the Dutch economy, may not only be seen neutrally, but even as a good thing. The sector might have been the basis for further growth during the 19th century, maybe even supported a new industrial revolution after the British model. Ironically, however, crises in the financial sector brought about the downfall of first the political structures of the old Republic, and finally the near-demise of the Dutch economy (most of all the financial sector) in the first decade of the 19th century.

The Fourth Anglo-Dutch War, which from the English point of view was caused by Dutch greed in supporting the American Revolution with arms and funds (the British pretext for declaring war was a draft-treaty of commerce between the city of Amsterdam and the American revolutionaries) brought about a liquidity crisis for the VOC, which almost brought down the Bank of Amsterdam also, as this bank had been making "anticipatory" loans which the company could not pay back. Both were saved by the government, especially the States of Holland, which provided emergency credit, but financial confidence was severely damaged. Investor confidence was also damaged by the political troubles of the Patriot Revolt after the war. That revolt was sparked by popular demand for thoroughgoing political reforms and reforms in public finance, to cure the ills exposed by the dismal conduct of the war by the regime of Stadtholder William V. When his regime was restored by Prussian force of arms, and the would-be reformers were driven into exile in 1787, many investors lost hope of economic improvement, and they started liquidating their assets in the "real" economy for a flight in foreign bonds and annuities (especially French ones, as the French monarchy happened to have a large borrowing requirement at this time).

When soon afterward the French Revolution of 1789 spread by military means, and put the exiled Patriots in power in a new Batavian Republic, for a while the reform of the state, and the reinvigoration of the economy, seemed to be assured. Unfortunately, the reformers proved to be unable to overcome the conservative, federalist, sentiments of the voters in their new democracy, and it took autocratic measures, first French-inspired, later by direct French rule, to reform the state. Unfortunately, the influence of the French on the economy was less benign. The French "liberators" started with exacting a war indemnity of 100 million guilders (equal to one-third of the estimated Dutch national income at the time of 307 million guilders). They did more damage, however, by first defaulting on the French public debt, and later (when the Netherlands were annexed to the French empire after 1810) on the Dutch public debt. This was the first such default for the Dutch ever. Bonds that had paid a dependable income since 1515 suddenly lost their value. This loss devastated the financial sector as up to half of the national wealth (and the source for future investments) evaporated with the stroke of a pen. Napoleon concluded the process of destruction of the Dutch economy by enforcing the Continental System effectively, snuffing out Dutch contraband trade with the British, while at the same time keeping French markets closed to Dutch exports even when the Netherlands were part of the French empire.

Consequently, Amsterdam lost its position in the international capital market forever to London. The merchant bankers left en masse. Though for a while cities in the maritime Dutch provinces lost urban population, while grass grew in their streets, and their ports were empty, and even though the Netherlands' economy experienced deindustrialization and pauperization, with a concomittant re-agriculturalization, it did not revert to premodern days. It even managed to hang on for another fifty years, resistant to attempts at industrialization in the British mode, even though those attempts did take hold in the former Southern Netherlands, with which it shared a state until 1830. Only in the mid-19th century, after the final liquidation of the repudiated public debt (and the attendant restoration of public credit) did the Dutch economy start a new epoch of modern economic growth.