Every empire learns the same painful lesson: Credibility in finance is hard won and easily lost. Venice in the 17th century, Britain in the 20th and perhaps the United States in the 21st all faced the temptation to paper over fiscal stress with loose money and weak currency, with disastrous results. A new paper reminds us that even the world’s most trusted currency can unravel quickly if fiscal dominance takes hold.
Italian economists Donato Masciandaro, Davide Romelli and Stefano Ugolini published a fascinating new paper in Explorations in Economic History, examining one of the earliest experiments with a managed float of state-issued money: the Venetian ducat between 1619 and 1666. Their study offers more than just a historical curiosity; it provides a cautionary lesson for today’s United States, where debates over debt sustainability, loose monetary policy and the dollar’s role as the world’s reserve currency are front and center.
Venice’s Early Experiment in Fiat Money
In 1619, the Republic of Venice created the Banco del Giro, a public bank that issued inconvertible fiat money to help the government finance its operations. Unlike metallic coins or convertible notes, this money’s value floated against both domestic coins and foreign currencies. The bank operated under a system of fiscal dominance—its balance sheet expanded and contracted directly with the government’s fiscal stance.
The government, despite its reputation for fiscal prudence, used the Banco del Giro to cover short-term deficits during crises. Two shocks in particular tested the system:
1. 1630 (Plague & War): Facing famine, war and the bubonic plague, Venice sharply increased Banco liabilities. The ducat depreciated rapidly, only to recover once the Senate imposed contractionary measures.
2. 1648–1650 (Cretan War): Again, military pressures forced the government into monetary expansion, producing depreciation. When spending pressures eased and the government tightened policy, the currency quickly appreciated.
Using newly digitized high-frequency exchange rate data from archival sources, the new study shows that fiscal monetization had an immediate and significant impact on the external value of the ducat, even though Venice had centuries of fiscal credibility. In short: Reputation alone could not shield the currency from the consequences of fiscal dominance.
The Core Lesson
The Venetian case demonstrates three key points:
1) Fiscal policy drives credibility. Even when governments enjoy reputations for prudence, markets respond sharply to signs of fiscal monetization.
2) Currency depreciation is not always inflation. In Venice, fiscal dominance showed up more in external exchange rates than in domestic commodity prices.
3) Time consistency matters. Investors quickly rewarded the Republic when it returned to fiscal discipline but penalized it immediately when it deviated.
Masciandaro and his coauthors conclude that the external credibility of an international currency depends less on formal monetary regimes (convertibility vs. floating) and more on fiscal stance (Ricardian vs. non-Ricardian behavior).
The United States Today
Fast-forward four centuries. The U.S. dollar remains the world’s dominant reserve currency, much as the Venetian ducat once anchored Mediterranean finance. But the parallels are both striking and troubling.
· Loose Monetary Policy: Since his first term, President Trump has pushed for persistently low interest rates, pressuring the Federal Reserve’s independence.
· Dollar Depreciation: In Trump’s second term, the dollar has weakened against major currencies. Some commentators have even speculated about a “Mar-a-Lago Accord,” a deliberate strategy to reduce U.S. debt burdens by eroding the dollar’s value.
· Fiscal Pressures: With debt at historic heights, concerns about fiscal sustainability have intensified. Rising interest costs make the temptation of “monetization through depreciation” all the more real.
As in Venice, these pressures are all connected: Dollar depreciation, lax monetary policy and debt sustainability form three links in the same chain. If fiscal dominance takes hold and monetary policy accommodates fiscal needs, trust in the dollar’s external value could erode.
The lesson from Venice is stark: International credibility is not indestructible. Just as the ducat could not withstand repeated episodes of deficit monetization, the dollar cannot forever rely on America’s past fiscal reputation if policy moves in a persistently non-Ricardian direction.
Why This Matters
The Venetian experience shows that credibility can unravel quickly, but also that it can be restored if governments return to discipline. The U.S. is still able to avoid a credibility crisis. But history suggests that if fiscal dominance becomes entrenched, depreciation of the dollar’s external value will follow even if inflation at home seems subdued at first.
The world’s reserve currency carries enormous advantages, but also heavy responsibilities. Reputation, once squandered, is hard to rebuild.