Sovereign Debt Issuance and the Transformation of the Monetary Architecture in Prussia and the German Empire, 1740–1914
Why did we commission this paper?
Germany has a rich and mixed history of public finance. In this history, both its current preoccupation with low debt-to-GDP ratios and the turbulent mid-20th century period with four sovereign defaults between 1924 and 1945 are well known. Less well known, however, is the fiscal history of German-speaking states prior to the 20th century. Given that the 19th century saw a customs union, a political union, and a monetary union emerge among those states under Prussian leadership, all in a context of intense geopolitical competition and rapid structural changes to the economy, we suspected that a deeper understanding could provide useful context for our own historical moment. We also suspected that a deep dive into the 18th and 19th centuries would show a greater variety of macro-financial arrangements than we are familiar with today. By reminding ourselves of this variety, by studying what did and did not work, and by showing that it was Prussia of all places that experimented with different public debt arrangements, we aim to make space for a more open-minded discussion of public debt and fiscal policy today.
What did we learn?
Steffen Murau’s paper provided us with a wealth of insight. Besides demonstrating how colourful Prussia’s and imperial Germany’s macro-financial history is, three lessons crystallised for us.
First, off-balance sheet fiscal agencies (OBFAs) were a normal part of that architecture, especially whenever fiscal policy was constrained by debt brakes or other obstacles to sovereign debt issuance, as was the case for Prussia between 1820 and 1850 and again between 1860 and 1866. Their use goes back further than we originally thought and was more frequent and extensive than we had suspected. It was particularly striking in the context of high-priority state projects, whether roads, railways, and canals, the construction of urban infrastructure to accommodate a rapid influx of population, or – of high relevance, given the 19th century’s many wars – military spending. OBFAs, and especially Prussia’s Seehandlung, enabled those projects to go ahead despite a fiscal order that sought to constrain their funding to taxation and other current sources.
Second, the effectiveness of Prussia’s central bank – first the Königlich Preußische Bank, then the Preußische Bank, which eventually transformed into the Reichsbank — was more mixed than we originally thought. During its “public” – at that point royal – phases, where it had no private shareholders, it did not stabilise financial markets or support sovereign debt issuance effectively. Once it had settled into a more hybrid institutional structure, involving private shareholders, it became more effective. Interestingly, in the period up to 1914, the Reichsbank regularly bought significant parts of sovereign bond issuances, as did the Seehandlung, while Germany did not experience any major adverse effects on inflation or confidence in public debt.
Finally, the consequences of changes in the private sector’s institutional role were surprising. When major private banks played a more important institutional role in sovereign bonds issuances, via the Prussia Consortium and the Imperial Bond Consortium, this extended the volume of debt that could be issued and funded. Rather than disciplining debt issuance, they crowded in other private investors, highlighting the importance of trust between the state, banks, and the holders of private capital.
Erratum: On page 3 we changed the year “1924” to “1923” and uploaded a new version on 15.02.2024.
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