Arnold Kling  

Odious Debt

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Barry Eichengreen writes,


Only the delusional can believe that, when everyone else is taking swingeing cuts, Greece's creditors can continue receiving 100 cents on the euro. It beggars belief that Greek government debt can top out at 150% of GDP, as the IMF envisages. At this point the government will be transferring well more than 10% of national income to the creditors. In a time of severe austerity, this outcome is unsustainable both economically and politically.

Sooner or later, the creditors will have to exchange their existing bonds for new ones worth at most 50 cents on the euro. This will leave Greece with more public money for basic social services. That in turn will make it a tiny bit easier to achieve social consensus on the needed austerity measures. It will show the Greek in the street that he is not simply making sacrifices to pay the banks.

In short, he is saying that Greece is bound to walk away from its debt.

My guess is that one reason that the European financial community is in denial is that marking down the value of Greek debt would cause the balance sheets of some European banks to look a bit dicey.

Meanwhile, back here in the U.S., we get this cheerful news:


The key data point in Moody's view is the size of federal interest payments on the public debt as a percentage of tax revenue. For the U.S., debt service of 18%-20% of federal revenue is the outer limit of AAA-territory, Moody's managing director Pierre Cailleteau confirmed in an e-mail.

Under the Obama budget, interest would top 18% of revenue in 2018 and 20% in 2020, CBO projects.

I guess that the thinking is that once debt service reaches a certain amount, the U.S. government will not be willing to transfer so much our GDP (roughly 4 percent) to creditors. I mean, just because creditors lent on good faith does not mean that they should get their money back, does it?

In the literature on third-world governments, there is a theory of "odious debt," meaning that the people of one of these godforsaken countries should not have to be responsible for paying off the debt incurred on their behalf by their evil leaders. How does the theory of odious debt apply to Greece? To the U.S.?

It seems to me that the only way to prevent governments from accruing odious debt is to not lend to them. That would require a few minor changes in government behavior. It would make Keynesian stimulus a bit difficult to carry out. It might make it necessary to fund stuff like Social Security and Medicare with real assets, not IOU's.

If government debt is odious whenever paying it off would be painful, then isn't government debt always odious?


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CATEGORIES: Fiscal Policy



COMMENTS (15 to date)
Ricardo Cruz writes:
In a time of severe austerity, this outcome is unsustainable
I thought the time of severe austerity was the outcome of the debt bills coming due, not the other way around. ?!
Yancey Ward writes:

Isn't government debt really a case of "last bagholder"? The debt is continuously rolled over until it isn't, or it ends up on the balance sheet of some other sovereign nation where it is continuously rolled over until isn't. Eventually, you end up with a last bagholder and no one else willing to step up and make you whole.

Boonton writes:

Or the EU could simply pay off, say, half of Greece's debt and maybe a quarter of Spain's and call it a day and still have a lower debt-to-GDP number than the US. The problem appears to be that if you're going to have a currency union you have to work at bringing your lowest members up to your standard of living. I'd imagine the US would have the same problem if, say, Mexico became the 51st state.

Speaking of debt-to-GDP ratios, I think you may have unintentionally created some confusion by mixing two different ratios. Greece is talking about 10% of GDP as debt service. You cited US debt service as 20% of Federal Revenues. These are two very different numbers.

Federal Revenue is something like 20% of GDP so 20% debt service would basically be about 2% of US GDP. Apples to apples would mean something like the US having 50% of its Federal Revenue going to debt service, not 20%.

Missing from this discussion is also Japan, which last time I checked is near 200% of debt to GDP and seems to have none of these troubles. The problem here is no so much odious debt but odious political dithering. Greece and the EU needs to choose a path and stick to it. The longer they hold off on that the more the crises will grow.

Yancey Ward writes:

"Missing from this discussion is also Japan, which last time I checked is near 200% of debt to GDP and seems to have none of these troubles" yet. Fixed that for you.

And, well, no, the EU wouldn't be paying off the debt under your proposal- they would simply be spreading it out amongst the other member countries.

kurt writes:

Why wasn't Greece allowed to talk to its creditors in order to restructure its debt? Let Greece default, banks and insurance companies will take a 20% hit on their Greek assets, and if necessary, one can talk bailouts then. Would have been much more transparent IMHO.

SydB writes:

"If government debt is odious whenever paying it off would be painful, then isn't government debt always odious?"

Yeah. That's why George W Bush and Ronald Reagan were both such bad presidents.

Arnie writes:

Germany needs to let the euro tank and let Greece go belly up. Bitter pill now instead of dagger-to-the-heart in the morning.

Now....
In a similar "vein", my father and grandfather both held the belief that if was fundamentally wrong to even buy US Treasuries. Some sort of application of the Old Testament usury restrictions. (Not a jewish family, rather fundamentalist evangelical.)

We are definitely in need of a completely new set of investment vehicles that simply don't exist today which are built on trust and correctly-enforced contract agreements.

Walt French writes:

“…I mean, just because creditors lent on good faith does not mean that they should get their money back, does it?”

Seems odd that a person with your education in econ would put these events in the “fool me once, shame on you” category. There's a long history of sovereign defaults; in Greece's case you don't even have to turn back many pages.

And recent history has no shortage of examples where private capitalists likewise put their losses to the government. Whether in formal bankruptcies (Lehman, WaMu, WorldCom, GM…) or Hank Paulson telling the Chinese he would personally back the explicitly-NOT-full-faith-and-credit GSEs, or the TBTF Citi and AIG takeovers, there are examples aplenty of capitalists eating society's cake and then leaving the dirty dishes.

(The fact that individuals in some bankruptcies above will yet be, or currently are, doing hard time, suggests that mere bankruptcy is hardly the guarantee against financial failures that some would like to think. Ditto, look at the approximately one thousand felony convictions stemming from “looting” in the S&L crisis. And Icelandic bankers' total losses of personal capital, and possible prison time doesn't seem to have discouraged them from utterly bankrupting that country.)

The limited liability corporation may be one of the great inventions of business, but even pure Modigliani-Miller types recognize that at some point, failure happens. Those failures seem more likely all over -- public, corporate and personal -- when we're levered up to our eyeballs. And yet, the consensus is that leverage is necessary to get any growth, and that any attempts to control it is an assault on the legitimate pursuits of capitalists.

The suggestion has been made that low inflation, and the attendant low nominal yields on debt, helped fuel the leverage boom of the last couple of decades as firms looked to create nominal wealth. (I think it's also relevant that in the same time frame, investment banks went from partnerships, where a principal could lose all, into corporations, which allow management or even senior shareholders, to drain out actual capital without fear of clawbacks.) That'd be scary: human nature might have made the bond vigilantes' wishes perverse.

Tracy W writes:

Arguably a democractic government shouldn't have a right to borrow money at all. If I voted for the opposition, or didn't vote as a result of being too young, what right does the government of the day have to commit me to paying later on for its decisions?

But it really is convenient for government to be able to borrow money. So the question is "who can bell the cat?"

As for the Greek case - I understand the problem is that the Greeks want to keep on borrowing money, so if creditors take a 50% cut, the Greeks presumably won't be able to keep borrowing to the extent they want. Which is why they want to keep paying their creditors off.

Boonton writes:

yet. Fixed that for you.

I don't think so. With the discussion around the meme of "So goes Greece, so will go the US" is this undercurrent of an idea that hitting 100% of debt to GDP is some type of magic trigger (or 110%, 150% or whatnot). This ignores several facts:

1. On the personal and business level its quite often common to have debt to income ratios in excess of 100% without any problems.

2. Countries have often pushed past 100% without problem both today and in the past (i.e. the US post WWII).

3. Greece has a modern history full of debt defaults.

4. Greece rapidly increased its debt to GDP ratio even in absence of the recession.

5. Greece's ratio recently increased by some non-trivial amount due to accounting fraud.

Add to this the fact that Greece's debt is in a currency it cannot control while Japan (and the US) has debt in its own currency.

Finally, unlike Greece Japan's debt is traded in a very, very deep market. The idea that the market just hasn't noticed Japan crossing a magic number like 150% of GDP while Greece was just doesn't hold much water.


“…I mean, just because creditors lent on good faith does not mean that they should get their money back, does it?”

Well it wasn't technically lent on 'good faith'. Investors are well aware that buying debt has multiple risks including default, inflation etc.

Tracy

Arguably a democractic government shouldn't have a right to borrow money at all. If I voted for the opposition, or didn't vote as a result of being too young, what right does the government of the day have to commit me to paying later on for its decisions?

1. If you voted for the opposition you implicitly accepted the rules of the game. One of those rules are that 'your side' may loose some elections.

2. "You" don't have to pay anything back. No one is required to buy consumption goods in Europe today (thereby paying VAT taxes that pay off previous debts) nor are they required to earn income in the US (thereby paying income taxes which services debts incurred during Regan's terms). But you can't quite have your cake and eat it too. If you're going to participate in the 'European system' you deal with the whole system's karma which includes both its good and bad policies of the past. For example if you made your home in East Germany you can't quite demand your income be automatically boosted 20% and your home remodeled on the grounds that the place would have been much nicer if it hadn't gone to the Soviets post WWII.

Johnson85 writes:

1. If you voted for the opposition you implicitly accepted the rules of the game. One of those rules are that 'your side' may loose some elections.

No, you don't implicitly accept the rules of the game. You play the game b/c you don't really have an alternative.

2. "You" don't have to pay anything back. No one is required to buy consumption goods in Europe today (thereby paying VAT taxes that pay off previous debts) nor are they required to earn income in the US (thereby paying income taxes which services debts incurred during Regan's terms).

What about people that sell goods in Europe. Just b/c you're born in a certain area you become liable for the debts of others that used to live in that area.

And your US example is expecially poor, b/c if you leave the US and renounce your citizenship, the US can try to tax money you earn for a period of time thereafter, I think up to 10 years. So basically the U.S. thinks its citizens are part prisoners. No leaving without paying the piper.

AJ writes:

Greece borrows (and spends) more than they can pay back.

Secnario 1: They default or restructure (e.g. 25 or 50 cents on the dollar). Lenders take a loss. Lenders bear the risk of excessive lending. Future lending to governments is on terms which account for this risk. Excessive lending may be prohibitively difficult/expensive for some countries. Future excessive spending is disciplined by lending costs/difficulties.

Secnario 2: Greece debtholders are bailed out at 100 cents on the dollar by other countries. Creditors (private banks) are happy. Excessive spending and borrowing can continue by any government because of bailout probability. Excessive spending and borrowing continues at "subsidized" borrowing rates until the entire multilateral system collapses at a much higher level of disaster.

I fail to see what is wrong with Scenario 1. Why is this issue so complicated and why is it so important to the Euro or other countries? It seems the real issue is the private wealth of the lenders who want restitution rather than default or a restructuring.

AJ

Boonton writes:

No, you don't implicitly accept the rules of the game. You play the game b/c you don't really have an alternative.

Really? you don't have an alternative? 100% of the world's population lives and works in the EU and the rest of the globe is uninhabitable? You have plenty of alternatives, you just don't like them.

There is one alternative you don't really have. Which is to exist in a society with no past or shall we say that suffers no consquences of its past. No such place exists. But actually such a place does. Just get on board a raft and find an empty island somewhere.

What about people that sell goods in Europe. Just b/c you're born in a certain area you become liable for the debts of others that used to live in that area.

See above, you aren't required to sell anything in Europe. (Although this opens the question of whose really paying the VAT that services Europe's debt(s)? Are you paying it or are your customers really paying it and its just passing through your bank accounts on the way to the EU's Treasury accounts?)

AJ
I fail to see what is wrong with Scenario 1.

Nothing except that interest rates rise dramatically making life difficult for several EU countries. As those countries are forced to curtail spending even more their growth and incomes are slashed. Either the stronger EU countries come to their aid or they will suffer to the point that they say enough is enough, ditch the Euro and export their way back to full employment through a devalued currency.

The rest of the EU suffers from having the Euro represent a smaller economic bloc and seeing their exports suffer as the weaker countries 'begger they neighbor' their way out of recession. Which brings us to scenario 3:

3: The EU gurantees the debt of countries in trouble. Greece & co roll over their debt at the usual interest rates in exchange for serious but not suicidal spending cuts. The cost today to the EU is essentially nothing. It does take the risk that Greece will default downt he line in which case it must make good but this risk is minimized by:

a. The fact that rates are now lower for Greece easing its burden.
b. The fact that the EU would force the default on newer, post-crises debt first. That means pressure on newer borrowing which means there's Greece doesn't exactly get a total 'get out of jail free card' from the bank or moral hazzard.

AJ writes:


This is the naive Keynsianism we need to explode. Interest rates are not higher for responsible governments. Overspending beyond your means by one European Country does not promote it's living standard. Surely, someone is teaching economics out there.

AJ

I fail to see what is wrong with Scenario 1.

Nothing except that interest rates rise dramatically making life difficult for several EU countries. As those countries are forced to curtail spending even more their growth and incomes are slashed. Either the stronger EU countries come to their aid or they will suffer to the point that they say enough is enough, ditch the Euro and export their way back to full employment through a devalued currency.

AJ writes:

I can make it even easier to understand:

Greece is not paying it's debt back. Period. There are two scenarios:

1) Private bank lenders take the loss/writedown/default

2) Western governments, particularly in EU pay the loss to recoup the lenders.

It's no different than whether the U.S. bails out California or not.

AJ

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