STACEY VANEK SMITH, HOST:
Government bonds - in the U.K., they're called gilts. In German, they're called bunds. In France, they're known as obligation assimilable du tresor or OATs. In the U.S., we just call them treasuries. And they are an enormous part of our economy. Last year, the U.S. government raised more than a trillion dollars with government bonds.
And they work like this. You buy, let's say, a hundred dollars' worth of 30-year Treasury bonds. The government takes that hundred bucks and uses it however it wants - to help pave a highway or contribute to someone's unemployment check or mow the White House lawn. And in exchange, you get a regular payout every year until the 30 years is up.
At the current rate, you get about three bucks a year. Thirty years later, you also get your hundred dollars back, so $190 total not adjusted for inflation. It's a pretty slick system. But it's also kind of a weird system if you think about it. I mean, the government has all this money. And then citizens, like puny, little, broke citizens are lending the government money. So how did this get started?
WILLIAM GOETZMANN: Well, the actual creation of a government bond was an accident.
VANEK SMITH: An accident - and also, as it turns out, a desperate attempt to appease a bloodthirsty mob.
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VANEK SMITH: This is THE INDICATOR. I'm Stacey Vanek Smith. Today on the show, a bond is born - how the invention of the government bond saved a bunch of mid-level politicians from certain death and became one of the most important and influential pieces of financial technology the world has ever seen.
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VANEK SMITH: Venice, the 1100s - it is one of the most important and powerful cities in the world. It is New York and Paris and Beijing and Silicon Valley all rolled into one, a center for innovation, culture and global trade. Venetian merchants were stationed all over the world, collecting spices and cloth and jewels and furs. But Constantinople, another Middle Ages powerhouse, decided to make a move on Venice. It took this really dramatic action and imprisoned a bunch of Venetian merchants and seized their property. Venice had to respond.
GOETZMANN: The government of Venice got into a war. And it needed to build a fleet of ships in kind of a hurry. So it, basically, taxed all the people in Venice, raised money that way.
VANEK SMITH: Just like an emergency tax like...
GOETZMANN: Yeah.
VANEK SMITH: We need money for these ships, guys. Cough it up.
GOETZMANN: Exactly.
VANEK SMITH: William Goetzmann is the author of "Money Changes Everything." He says this emergency tax Venice levied was not your typical tax. The government said it would pay people back for this tax. It was basically a loan but not a loan. Loans were, actually, mostly illegal at the time because of religious usury laws. So it's kind of a tax loan situation. And the idea was that the Venetian fleet would sail over to Constantinople, crush the enemies, get its guys out of there, get all their seized stuff back, maybe some extra stuff, too, sail home triumphantly with a bunch of booty and pay everybody back.
GOETZMANN: It was a complete disaster.
VANEK SMITH: The Venetian fleet got hit with the plague. Thousands of people died. The mission was cut short, and the surviving Venetians came home in defeat.
GOETZMANN: Only about 25 percent of the people that went out came back.
VANEK SMITH: Oh.
GOETZMANN: Actually, the doge, the head of Venice, had gone out on this expedition. He did come back. And he got off the ship. And when the Venetian people saw that he survived but so many of their family perished, they chased him down the street and executed him.
VANEK SMITH: Oh.
GOETZMANN: So this was, really, a serious situation.
VANEK SMITH: Venice's governing council was like, uh oh. They did not have the money to pay back the tax loan. And the mob was not in a mood to be told no, so they came up with a plan.
GOETZMANN: What they did is they said, well, we're going to pay you every year something like 6 percent of what you had to come up with. And we're going to keep doing that until we can pay you back.
VANEK SMITH: The bond was born - or the prestiti, actually. That is what they were called - prestiti. It was kind of like a loan that you'd given the government. But unlike a loan, where you would get paid back all at once with interest, with the prestiti, you'd get paid back little by little in regular payments that you could count on. It became really popular - so popular that people started trading them in the famous Rialto Market.
GOETZMANN: The biggest bridge in Venice across the canal is the Rialto Bridge. And if you go over that bridge, which is usually filled with people selling you all sorts of things...
VANEK SMITH: And taking selfies (laughter).
GOETZMANN: Yeah, exactly. And that square was where the bankers would set up their tables. And so, you know, you squint your eyes, and you can see back 800 years.
VANEK SMITH: Venice realized it had a hit on its hands and a really important hit.
GOETZMANN: It was, really, a fantastic innovation for governments because now governments could - instead of just taxing people and having them get angry, they could sell them bonds.
VANEK SMITH: Bonds - a way to raise money that did not make people murderously angry. People loved them as a safe investment with payments that you could count on. And governments loved them because they could raise money for big, ambitious, risky projects - the kind of projects that might make people angry if their tax dollars were funding them. William says in this way, the bond basically unlocked all of this wealth in western Europe.
GOETZMANN: Instead of having to very slowly accrue taxes and save them and - you could get things done quite rapidly. It meant that, in some sense, cities could punch above their weight in terms of raising armies but also building things that needed to get built.
VANEK SMITH: Spain used bonds to help fund shipping expeditions to South America. Holland used bonds to build dikes. Western Europe started growing at an unprecedented rate. In fact, says William, China, which had been leaps and bounds ahead of Europe in terms of wealth and technology, started to fall behind, partly because of the money raised through government bonds.
GOETZMANN: At this time, in the 1100s and 1200s, Europe was, really, a backward place compared to China. The Chinese did not have this financing technology. They didn't issue bonds. So after about 1400, Europe takes off compared to China by many different kinds of measures. Eventually, the Industrial Revolution occurs in Europe but not in China.
VANEK SMITH: William says bonds helped Western European economies grow at the speed they did and to the scale they did. In the U.S., bonds helped fund the Revolutionary War and build railroads out across the undeveloped prairie. Of course, bonds had their fair share of problems, too. I mean, they make it really easy for governments to take on a lot of debt. And people have gotten used to thinking of them as a really safe investment.
During the financial crisis, countries like Portugal, Greece, Spain and, ironically enough, Italy, took on way too much debt and got their economies into a lot of trouble. Even still, bond sales continue to be a crucial way for governments to fund their operations. In fact, last year, the U.S. raised about $1.3 trillion through government bonds - the most since 2010. And it was all thanks to this innovation from Venice in the 1100s.
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VANEK SMITH: THE INDICATOR is produced by Darius Rafieyan, edited by Paddy Hirsch. Our intern is Willa Rubin. And the music you're hearing is actually from 12th century Italy. It's performed by the Ensemble Organum.
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