------------ EH.NET BOOK REVIEW --------------  
Published by EH.NET (May 2006)  
  
James Macdonald, _A Free Nation Deep in Debt: The Financial Roots of   
Democracy_. Princeton: Princeton University Press, 2006. ix + 564 pp.   
$20 (paperback), ISBN: 0-691-12632-1.  
  
Reviewed for EH.NET by Robert E. Wright, Stern School of Business,   
New York University.  
  
  
Storied trade publishing house Farrar, Straus and Giroux (FSG)   
published _A Free Nation Deep in Debt_ in cloth in 2003 but did not   
see fit to send a copy to EH.Net for review. Princeton University   
Press, the publisher of the new paperback edition technically   
reviewed here, is taking closer aim at the scholarly market. That is   
likely a good call. Though ably written, this book is closer in tone,   
density, and substance to a scholarly tome than a bookstore   
blockbuster. Likely, FSG was attracted to the book's Niall   
Ferguson-esque Big Thesis: Democracies eventually defeat autocracies   
because "countries with representative institutions are able to   
borrow more cheaply than those with autocratic governments" (p. 4).   
Bond markets also strengthen democracies internally by giving   
citizens some of the proverbial power of the purse and by aligning   
their interests with those of their governments. Heady, important   
stuff.  
  
To prove his thesis, James Macdonald, a British investment banker and   
independent scholar, has written a wide-ranging survey of the   
co-evolution of representative governments and public debt markets.   
He starts with the Old Testament, which he uses as a primary source   
to explicate the transition of societies from a Lockean state of   
nature to autocracy. Small family groups that highly valued leisure   
were subsumed or slaughtered by larger and more powerfully organized   
autocracies that forced their subjects through taxation to create   
economic surpluses. Autocracies soon came to control much of the   
ancient world but found it impossible to control the vast expanses of   
Asia, the forests and fjords of Northern Europe, or the jungles of   
Africa. A few small city states, often strengthened by alliances with   
other nearby cities, also managed to hold off the imperial advance   
for a time.  
  
The ancient autocracies financed wars from savings, their legendary   
"treasure troves," and equity contracts that divided the spoils of   
war. The democratic city states, by contrast, borrowed to fund   
resistance to imperial encroachments. "The picture that emerges,"   
however, was "not of a regular system of public finance, but of a   
series of improvised reactions to fiscal emergencies" (p. 36). The   
ancient Greeks, for example, moved toward modern public credit but   
never explicitly connected "the principle of voluntary contribution   
to the public funds and the principle of distribution of surplus   
assets" (p. 36). The result was a dizzying array of debt instruments,   
some forced and some voluntary, some paying interest and others not,   
most short-term but some in the form of life annuities. The Greeks   
sometimes found it difficult to honor their obligations but the   
extant documentation is too sparse to say anything more definitive   
about their creditworthiness.  
  
Modern public finance had to await the emergence of a different group   
of city states some 1,500 years later in the northern Italian   
peninsula. There emerged, for the first time since the fall of   
Carthage, a group of states run by merchants instead of soldiers.   
Desperate to maintain their freedom from regional despots, the   
representative governments of Venice, Florence, and Genoa hit upon   
the notion of repayable taxes, levies upon which interest would be   
paid if the government's finances allowed. To evade the Church's then   
stringent usury prohibition, repayment of the principal sum was left   
at the pleasure of the government. The Venetians circumvented that   
inconvenience by making the right to receive the tax repayments   
transferable to third parties, which quickly led to the creation of a   
secondary market. "They had invented the bond market" (p. 77) as   
Macdonald writes, but the Italian city states did not regularly pay   
interest on their repayable taxes, the market prices of which   
spiraled downward. City states in northern Europe eventually improved   
upon the Italian model by avoiding forced loans and repayable taxes   
and religiously servicing their debts. The Dutch Republic was the   
major innovator here.  
  
Medieval and Early Modern European autocrats also borrowed but almost   
invariably eventually defaulted. Unsurprisingly, they could not   
borrow as much or as cheaply as the Dutch, who won their independence   
by wearing down the once mighty Hapsburg Empire. By the end of the   
80-year struggle, a majority of Dutch households were creditors to   
their government. Default, rebellion, or large scale tax evasion   
became unthinkable because the interests of the government and the   
citizenry were thoroughly intertwined.  
  
After revolutions of their own in 1688 and 1776, the British and the   
Americans adopted Dutch-style finance, funding their wars in large   
measure by selling bonds to citizen creditors rather than resorting   
to punitive levels of taxation, ruinous inflation, or physical   
coercion. The democracies thrived, while autocracies in France,   
Germany, Russia, and elsewhere lost wars and rebellions. By World War   
II, however, government wartime financial techniques, including   
financial repression, rationing, and payroll deduction, had become so   
powerful that the great patriotic bond drives of earlier wars lost   
much of their importance. The wartime financial system of that   
greatest of autocrats, Adolf Hitler, looked eerily similar to that of   
the United States.  
  
If Macdonald is right -- and there is more than a little truth in   
this book -- then adherents of the English "Country" and American   
Jeffersonian Republican traditions exaggerated the negative aspects   
of national debts. Far from endangering democracies, national debts   
bolstered them by enabling them to defeat powerful external and   
internal foes. Eternal interest was as much the price of liberty as   
eternal vigilance.  
  
Authors who dare proffer such a Big Thesis confront numerous   
tradeoffs, the most important of which is that between depth and   
breadth. A twenty-page bibliography is always impressive, but less so   
for a book that covers several millennia of finance, government, and   
politics. Specialists will likely be disappointed with the treatment   
of their areas of expertise. (I cringed at several points in his   
discussion of the early U.S. monetary and financial systems.) But   
readers should concentrate on the forest rather than the trees and   
judge this ambitious and important book on its panoramic vision.  
  
  
Robert E. Wright teaches business, economic, and financial history at   
the Stern School of Business, New York University. His most recent   
books include _The First Wall Street: Chestnut Street, Philadelphia,   
and the Birth of American Finance_ (Chicago, 2005) and _Financial   
Founding Fathers: The Men Who Made America Rich_ (Chicago, 2006, with   
David J. Cowen). He is currently working on a book tentatively titled   
_Financing Freedom_ that will describe how the entire financial   
system, not just the government securities market, enabled America to   
vanquish its most dangerous enemies at home and abroad.  
  
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