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May 22, 2012

Californian, Grecian Debt: Deja Vu All Over Again

In a post titled A Precedent for that California Problem, Grim looks at the response to a Greek debt default in Medieval times:

Apparently this massive-debt-default situation has come around before... oddly enough, also in Greece. Medievalists.net has the article (h/t Medieval News). An heir to the disputed throne of Byzantium asked the army assembled for the Fourth Crusade to assist him in claiming that throne. In return, he promised a lavish payment as well as substantial military support during the Crusade.

Soon after becoming Alexos IV, however, it proved that the newly-made emperor could not pay up.

As the old saying goes, hilarity ensued. I was struck by Grim's use of "oddly enough" with regard to Greece and the threat of sovereign default (the inability or outright refusal of a nation to pay its foreign debt). If anything is odd about Europe's present debt crisis, it is that so few people are talking about just how common it is for nations to default on their debts:

Kenneth Rogoff: There have been hundreds of defaults in countries you might not imagine would have defaulted. So Greece defaulted many many times, Austria, Germany, France has defaulted eight, nine times in its history.

Justin Rowlatt: I have got an extraordinary table in front of me. England has defaulted three times, most recently in 1594. But as you say, Greece has previous record in terms of sovereign defaults. They have had one, two, three, four, five sovereign defaults, most recently in 1932. Why this pattern of default with Greece?

Kenneth Rogoff: Well, it's common to everybody. There are very few countries that don't have a history of serial default doing it again and again. It just takes time to grow from being an emerging market to a modern economy and virtually everyone went through that stage. Imagine that England's last was in the 1500s. That's default on foreign creditors. They have had domestic ones after that. But a country like Spain has defaulted 13 times…

Justin Rowlatt: I was going to come on to that; the Spanish state has the longest record of sovereign debt default, doesn't it?... when you look at the current European situation that record of Spain defaulting again and again; I mean just in the 20th century, they defaulted in 1936, 1937, 1938 and in 1939, why was anyone lending money to Spain in that period?

Kenneth Rogoff: Well, first of all, creditors get a risk premium for making these loans, so they get higher interest payments during the period where they are getting paid. The lenders to Greece were getting a premium for a long time. They want to be paid in full, but if they were so sure they ought to get paid by the Germans, why were they charging higher interest rate in the first place? That's part of it. And there are other countries that everybody thought would default, but never did and Australia is an example where they've borrowed like crazy. When I worked at the International Monetary Fund in the early 1980s, everybody thought Australia was going to default but it didn't.

Justin Rowlatt: Looking at this history, this long history of sovereign defaults, on balance has it been a good or a bad thing for the countries that have chosen to say, "listen guys, we simply can't pay our debt?"

Kenneth Rogoff: I think when your debt gets too high, there comes a point where just defaulting is the best option and that's what countries eventually do where you don't have the political consensus to engage in the austerity measures to do what's needed to pay.

The frequency of sovereign defaults may be one of the great, underappreciated truths of our time. For those who haven't read it, I can highly recommend Rogoff and Reinhart's This Time Is Different. For me, the takeaways were:

1. It's not at all unusual for nations to simply refuse to pay their debts. Risk assessments based on just a few decades of history are fundamentally flawed. They will, for instance, miss the risk of a 100 year flood, often with disastrous results.

2. Sovereign defaults tend to occur in clusters.

3. There is no fixed % of debt to GDP at which nations default. Sovereign default appears to be more a matter of political will - and national character - than anything else.

That last statement may be the single most alarming insight of all, given our current course.

Posted by Cassandra at May 22, 2012 08:49 AM

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"3. There is no fixed % of debt to GDP at which nations default. Sovereign default appears to be more a matter of political will - and national character - than anything else.

That last statement may be the single most alarming insight of all, given our current course."

True that.

A brief history of sovereign defaults... Excellent.

This comment brought to you by the letters U, S, & D and the shrinking symbol $.

*K turns and heads off to kick Oscar's can*

Posted by: Kermit at May 22, 2012 10:27 AM

As you correctly demonstrate, sovereign default has not been an area in which I've focused any serious historical research. Really, I was more interested in the Fourth Crusade aspect of it than the modern parallel -- I just thought that the modern parallel might make it interesting to readers.

Anyway, the new paper mentioned in the Medievalists article is really interesting. Those interested in that period would be well served by reading it.

Posted by: Grim at May 22, 2012 10:47 AM

As you correctly demonstrate, sovereign default has not been an area in which I've focused any serious historical research.

That wasn't really my point though :) I literally had no idea sovereign defaults were that common either (despite how many years of articles about the financial crisis?) until I read the book.

That was really more my point - here we've all been talking around this problem as though defaults were some uncommon phenomenon, when in fact they're really not!

The other thing I wanted to work into this post, but didn't have time to do coherently, was that Teddy Roosevelt's gunboat diplomacy is a great example of the United States using force to impose "supersanctions" on debtor nations who owed us money.

In 1882, Britain invaded Egypt for this reason. In the 1890s we used gunboat diplomacy against Venezuela (a serial defaulter) and again in 1915 against Haiti.

Kind of interesting, no? I didn't make the connection until reading your post!

Posted by: Cassandra at May 22, 2012 11:18 AM

Following the end of World War II, Great Britain sent John Maynard Keynes to the United States to negotiate a loan to rebuild our Atlantic cousin's shattered infrastructure and economy. The Wikipedia entry on the Anglo-American Loan saves me from troubling you with my own "misremembered" version of the details. Long story short, the Brits paid, as anyone familiar with that nation's character might expect they would.

Of course, it is still Wikipedia, so you'll not be surprised by the obvious inconsistencies within the entry. For example: In its first sentence the entry states:"The loan was made primarily to support British overseas expenditure in the immediate post-war years and to implement the Labour government's welfare reforms." Later, the same entry cavalierly dismisses the same statement:

In Television: Sir Christopher Meyer presented a history of the loan and its effects in the BBC series Mortgaged to the Yanks. Meyer erroneously claimed that the loan was primarily needed to pay for the Labour government's welfare reforms.
[Emphasis added.][I found a link to the video here. Ed.]

My passing grasp of the period leads me to believe the first statement to be the more accurate of the two. At the close of World War II the British were confronted with a host of social and economic ills at home and abroad. It was not just the sudden influx of millions of servicemen and war industry workers into an exhausted and impoverished economy, but also that the travails of war had awakened in the British people a sense of entitlement: We fought for Britain, and now we want our just desserts. Labor's "reform" programs were the populist reaction to these stirrings, and (I believe) staved off a far more drastic leftwards re-ordering of the British social and political system.

In my view, it is utter nonsense to argue that the Anglo-American loan was not the piggy bank for these programs. Indeed, I think that the use of the Loan proceeds to fund these "reforms" provides the best example the application of Keynesian economic principles to achieve short-term growth and stability.(Keynes negotiated the Loan ferchrissake.) Of course, as these "reform" programs had become entrenched, the British "welfare state" was born, and it's been circling the drain ever since.

Anyway, for those of you who are interested in such history, the debates that were held in the House of Commons over the Anglo-American Loan offer marvelous insight. (I LOVE the internet!) The British faced hard choices of meeting increasing social expectations at home, while struggling the loss of its empire and vastly diminished trade capabilities. The U.S. loan provided the means, at a price the British could not afford to refuse, and could not stomach to take. Underlying it all was the unwelcome realization that, from that point forward, the United States was calling all the shots. I think that you'll find the debates informed, frank and lively. In short, everything our own nation's modern political discourse is not.

Enjoy!

Posted by: spd rdr at May 22, 2012 11:58 AM

"...political will - and national character..." You have that exactly correct when it comes to California. We will probably default here in California, in the very near future, for 3 main reasons.

1. There is no problem; the first step in a solution is admitting you have a problem. While California is experiencing a large deficit the Governor is still full steam ahead on high speed rail. At last count the estimate is about 10 to 15 billion a year required.

2. Shifting demographics. Out of the ten million people that have come to California in the past decade or so more than half are on public assistance. Similarly, middle class folks, and their jobs, have been leaving in large numbers.

3. Finally, full blown delusion. I read an article this morning about how California needs to draw certain businesses here. The solution? More government spending via regulatory action.

I'm wondering what it's going to look like. Maybe I'm just a nativist, but I love California, and I hate to see what it's become.

Posted by: Allen at May 22, 2012 02:02 PM

...that Teddy Roosevelt's gunboat diplomacy is a great example of the United States using force to impose "supersanctions" on debtor nations who owed us money. In 1882, Britain invaded Egypt for this reason. In the 1890s we used gunboat diplomacy against Venezuela (a serial defaulter) and again in 1915 against Haiti.

Now that's an interesting point.

There's an ethical aspect to this. As the article pointed out, the Papacy has apologized for the sacking of Constantinople on several occasions. I'd guess that one of our Presidents -- Carter, Clinton or the current one -- has probably issued apologies for the invasions you cite.

We didn't invade Mexico when they nationalized the oil industry whose machinery had been built chiefly by US investors. No one thinks they owe us an apology for that; but when you go and get the money that's owed, it's generally considered wicked behavior. If Germany were to invade Greece to recoup its debts, for example, we'd be up in arms about it worldwide.

Posted by: Grim at May 22, 2012 02:28 PM

In my view, it is utter nonsense to argue that the Anglo-American loan was not the piggy bank for these programs. Indeed, I think that the use of the Loan proceeds to fund these "reforms" provides the best example the application of Keynesian economic principles to achieve short-term growth and stability.(Keynes negotiated the Loan ferchrissake.) Of course, as these "reform" programs had become entrenched, the British "welfare state" was born, and it's been circling the drain ever since.

This morning I was struck by a passage in one of the reviews of "This Time is Different". This part of your comment prompted me to look it up again and pass it along:

...excessive debt accumulation by government, banks, corporations, or consumers often brings great risk. It makes government look like it is providing greater growth than it is, inflates housing and stock prices beyond sustainable levels, and makes banks seem more stable and profitable than they really are. Large-scale debt buildups make an economy vulnerable to crises of confidence - especially when the debt is short-term and needs to be refinanced (the usual case).

We never learn, do we?

Posted by: Cassandra at May 22, 2012 05:18 PM

If Germany were to invade Greece to recoup its debts, for example, we'd be up in arms about it worldwide.

Germany's still a little gunshy about invading Greece -- it ended badly for them the last time they did it...

Posted by: BillT at May 23, 2012 03:01 AM

We never learn, do we?

*We* learn just fine.

The idiots who are in charge? Not so much.

Posted by: BillT at May 23, 2012 03:03 AM

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