The Public Debt Problem

A Comprehensive Guide

P. Lemieux

• Editorial: Palgrave Macmillan
• Año: 2013
• ISBN:
  9781137313027
• Categoría: Economics
• Categoría: Macroeconomics

The European public debt problem was in the making long before the 2007-2009 recession, as budget deficits had become endemic. A similar crisis is now developing in America, where the same fundamental causes have been at work. The Public Debt Problem analyzes the situation of public debts in America and reviews official forecasts for the federal government. The author carefully explains the main concepts (budget deficit, public debt, etc.) and analytical tools (discounting, government accounting, Treasury securities, bonds, yields, etc.) necessary to understand the issues.

CHAPTER 1

THE GENIE OUT OF THE BOTTLE

Just as one can practice safe sex, there used to be a way to do safe finance by holding safe assets. In its most general sense, an asset is anything that allows one to obtain goods and services in the future. In normal times, cash—actual dollar bills and coins—is the safest of all assets: you put it under your mattress and retrieve it when you need to buy something. The problem is that you don’t get any interest or other return on cash hoardings. It is better to put your money in the bank and earn some interest. Cash in the bank is pretty safe, especially since the federal government’s deposit insurance scheme protects you against bank failures. In times of inflation, of course, cash ceases to be safe, for its value diminishes as the prices of goods and services rise, but this problem can be ignored in normal times.

Safe State

Not long ago in our countries, something else was considered as safe as cash, while bringing a return higher than bank deposits: this other form of safe asset was government securities. These securities are the different types of bonds that governments issue to finance their deficits or sometimes their investments. (Private businesses also issue bonds as well as shares of stocks, another type of security.) The purchaser of a bond receives interest and, when the bond matures, gets his principal back. Since governments, and especially higher levels of government like the federal government in the United States, do not go bankrupt nor cease payments on their debt, it was thought, government securities are as safe as cash. Indeed, when you read in the financial press that businesses or banks are holding “cash,” this cash is usually government securities.

It is not that governments never default. On the contrary, they have often done so in the course of history. However, defaults of central governments among the major developed countries during the twentieth century have been exceedingly rare, and investors had become confident that, at least for those countries, the risk of holding government securities was, for all practical purposes, zero.

When a government does default, getting your money back is not easy. Ten years after the government of Argentina defaulted on $81 billion of bonds issued in dollars and sold to international investors, some creditors have still not agreed to the loss that was imposed on them. The government of Argentina had made a take-it-or-leave-it offer: accept 35 cents on the dollar, or you will get nothing. Some 93 percent of the bondholders ended up accepting the offer: better a 35 percent settlement than nothing. The remaining 7 percent rejected the offer, and have been trying since then to force the government to pay the full principal of the bonds plus accrued interest. Some of the original holders have chosen to sell their bonds, so that the current holders are not always among the original 7 percent. Many bonds were sold on the secondary market to so-called vulture funds, which have spent millions trying to get a full reimbursement from the Argentine government. Vulture funds are hedge funds (more risky investment funds) that buy distressed assets that have fallen to a fraction of their value, wait for the issuer to go bankrupt, seize its other assets, and try to make a profit by reselling them. The problem is that nobody can force sovereign states to go bankrupt and to be sold in pieces.¹

If the Argentine government decides not to pay the money it owes you, you will not be able to persuade its domestic courts to dissolve it, and to reimburse you with bankruptcy proceeds. You cannot hope to be reimbursed with government buildings, public roads, army equipment, police stations, and so forth. You may sue the Argentine government before the courts of your own country or a third country, but you will not be able to have the judgment enforced against a foreign sovereign. As an American judge reminded plaintiffs in the Argentine case, “You have rights but may not have remedies.” Hence the hurdle faced by holdouts on Argentine sovereign debt.

The vulture funds and a few other holders of defaulted Argentine debt have been fighting hard. Their strategy was to buy the bonds cheap and redeem them at a higher price. They have obtained hundreds of judgments against the Argentine government. Two vulture funds are sitting on $3-billion worth of favorable rulings. Since the Argentine government will not reimburse them, they have tried to seize money held by the Argentine central bank at the Federal Reserve Bank of New York, at the Bank of International Settlements (BIS), which is the central bankers’ bank, and in private banks outside Argentina. The lawyers of one hedge fund apparently served a subpoena to the BIS’s general manager just as he was about to speak at a public event. “His Excellency” was probably not happy! But all these efforts have failed. The creditors have had only symbolic successes, such as seizing $90 million from a New York trustee who was holding shares of a privatized Argentine bank, or seizing a few million dollars that the Argentine science ministry had deposited in an American bank account in order to buy telescopes. However, this activism probably means that the Argentine government cannot return to international financial markets until it reaches an agreement with its disgruntled creditors, as proceeds from the sale of Argentine bonds issued in an international financial center would likely be seized.

The Greek government has been more prudent. In early 2012, it proposed a deal to its creditor: you accept a loss (or “haircut,” as people in finance say) of three-fourths on your bonds, or else we will reimburse you nothing. A large majority of domestic bondholders accepted this offer under duress; the recalcitrants were later forced to swallow it by a retroactive law. But as in the case of Argentina, a minority of bondholders, some of them hedge funds, had bought Greek government bonds issued under foreign law, and refused to yield. The Greek government could not retroactively change the terms of foreign-law contracts. Greek finance minister Evangelos Venizelos had clearly warned the potential holdouts: “Whoever thinks that they will hold out and be paid in full, is mistaken.”² Yet, when the first of these foreign bonds matured in May 2012, the Greek government chose to repay it in full for €435 million. The holdouts had won! Needless to say that the bondholders who had been cheated by the Greek government’s bluff were not happy. It remains to be seen what the Greek government will do when a few billion euros more of the holdout-held bonds mature, but it is clearly fearful of holdout activism.

At least with foreign lenders, a sovereign borrower is not all-powerful. Yet, he is immune to many of the constraints that ordinary debtors face; he has sovereign immunity. He can walk away from his debt without being pushed into bankruptcy. That’s part of being a sovereign. The sovereign debt crisis in Europe has brought these facts to the forefront of the scene. And many more facts.

What exactly is the “sovereign debt”? A narrow definition refers to it as the debt issued by a national government but denominated in a foreign currency. What’s special about the sovereign debt in this sense is that foreign holders often have little legal recourse against a defaulting sovereign, as the Argentine case demonstrates. Their claims will not be recognized in the defaulting sovereign’s courts; if they are recognized, typically by foreign courts, they can’t be enforced anyway. Under the Foreign Sovereign Immunities Act, signed by President Gerald Ford in 1976, national governments may claim sovereign immunity from seizure of anything they own (or anything owned by one of their agencies) for noncommercial purposes. Even when a commercial purpose is involved, American courts are sometimes “deferring to Leviathan,” as The Economist recently put it in a case involving a hedge fund and a nationalized Irish bank.³ As we will see in this book, people often defer to Leviathan.

We will often meet Leviathan, but under different aliases. It is impossible to talk about the public debt and avoid him. Leviathan is the invincible Biblical monster to whom seventeenth-century philosopher Thomas Hobbes favorably compared the nascent modern state. One strand of contemporary economic analysis, related to the so-called Public Choice school, tries to understand the state, or the sovereign, as Leviathan.⁴ We shall see why.

According to a broader definition, sovereign debt is simply a sovereign’s debt, emphasizing the fact that the borrower, whether its creditors are locals or foreigners, is a sovereign with special status and special privileges. A defaulting sovereign often prevents his own nationals from enforcing their claims: after all, the sovereign is the one who, by definition, makes the law, including laws pertaining to his own obligations. The sovereign debt is not like other debts, like yours or mine. Not only can a sovereign block enforcement of claims against him, but he also can guarantee his debt with future tax receipts, that is, it can reimburse them with the future production and earnings of the taxpayers. In the broader sense, sovereign debt is synonymous with “public debt” or “government debt.” It covers the debt of subordinated government entities (such as municipalities or, in a federal country, states or provinces). I will generally use the term in its broader sense, and use it interchangeably with its synonyms.

Because of the sovereign’s power and immunity, government securities are not totally safe. This point has been brought home by the developing sovereign debt crisis. The Greek government, for instance, “restructured” its debt by promising to reimburse less than one-fourth of what it owed to its bondholders.⁵ Safe government looks more difficult than safe sex.

Mountains, People, and Governments

Our countries are not under the yoke of kings, so who exactly is the sovereign? And can we seriously say “he” when we talk about “it”? To answer the first question, the sovereign is simply the one, or the ones, who run the state. The state, in its more general sense, is the whole apparatus of government—executive, legislative, and judiciary—at all levels. In a democracy, it is claimed that the state is run by all citizens, and that “the sovereign,” “the state,” and “the people” (or “the public”) are more or less synonymous. A moment of thought suggests that the real sovereign is more often represented by the group of major politicians and bureaucrats who make most of the day-to-day decisions than by the electors who vote only occasionally. In any event, the state and the sovereign are closely related, and the distinction between them can often be neglected for all practical purposes.

We mean something slightly different, but related, when we say that the state is sovereign, when we talk about the “sovereign state” implying that sovereignty is an essential attribute of the state. This notion of sovereignty is external and pertains to the relation between the state and the world external to the country over which the state rules (compared to the internal power of the sovereign within a country). But the two uses of sovereign do have a common denominator: power. The sovereign state cannot be challenged by outside forces, just as the sovereign rules over his own subjects or citizens.

The answer to the second question—can we say “he” (or “she”) when talking about the sovereign?—is yes, provided we heed some caveats. In saying “he” for the sovereign, I am not implying that he is a single physical person, nor suggesting that the state is a sort of superindividual endowed with humanlike cells, organs, and brain. The sovereign is generally a group of individuals, even in autocratic regimes. But he often behaves as if he were a single person, in the sense that he naturally pursues the welfare of the rulers, “his” own welfare, and that he acts to reach this objective. These observations also apply to the state. The Greek state acts in its own interests when it tries to get subsidies from the European Union, its interests being the interests of those who rule or influence it. Similarly, General Motors acts in its own interests, that is, the interests of its shareholders and management. Each time a group is involved, there are of course conflicting interests, and it is the individuals closer to the center of power who succeed in imposing their own.

In certain cases, standard political terminology is so confusing that making and keeping clear distinctions is imperative. Consider the words “government,” “state,” and “country”: we use them sometimes to mean the same thing and sometimes to refer to very different entities. We say “the country has magnificent mountains,” “the country is aging,” and “the country [or, say, France] fights foreign imports.” Country names are used to refer to the geography, the people, or their political rulers. We say, “China is keeping the yuan undervalued” when we want to say “the Chinese government” or, more precisely, “the Chinese state” at all levels. Similarly, when we say that “the United States is fighting the war on drugs,” we mean in fact “the US government” or, more exactly, all the powers and levels of the US government, that is, the whole American state. We cannot mean that the Grand Canyon fights the war on drugs. We cannot either seriously mean that all Americans, “the people,” are fighting the war on drugs, for there are obviously Americans on both sides of the fight. We must distinguish between a country’s geography, its people, and its state.

American parlance promotes a further confusion between state and government. When, in America, we say “the government,” we often mean “the state,” that is, the whole apparatus of government—executive, legislative, and judiciary—at all levels—federal, State, and local. When we say, “the government is fighting the war on drugs,” the subject of the sentence includes Congress, federal and local judges, the States’ assemblies and administrative machines, the municipal councils and police, as well as the federal administration. Similarly, the judges and bureaucrats who enforce the tax laws in order to levy taxes and reimburse the public debt, as well as the politicians, are all part of the state. This is made more confusing by the fact that, in America, “States” refer to one level of government in the federal system. When we reserve the term “state” for this usage (describing a territorial division of government), we are left without a clear and distinctive term for the whole apparatus of government, which is rather inconvenient.

To try and clarify what we are talking about, I will often use “the state” to describe the whole apparatus of government at all levels. When, in contrast to “the state” in general, I want to refer to a particular State in the Union, or to several States, I will capitalize the term. I will speak of “the American state” in order to refer to the whole apparatus of government in America, at all levels (federal, State, and local) and with all powers combined (executive, legislative, and judicial).

I will also try, whenever it seems important, to distinguish states, countries, and peoples, by using, say, “the Greek state” instead of “Greece” when I want to talk about the state or the sovereign, as opposed to the Greek people or the islands of the territory. It is not clear that Greece has defaulted on its debt; indeed, many Greeks and many Greek businesses have not. It is the Greek state that has.

We are so accustomed to see government representatives and activities around us—in taxes, regulations, assistance, enforcement, and so on— that the state seems to be omnipresent and immortal. The state is naturally deemed to be a solid institution, the most solid of all. Everybody is supposed to trust it. This is why the sovereign debt is, or was, supposed to be totally safe. Those who continue to buy government securities still seem to think so. As The Economist writes with a whiff of British humor: “If governments aren’t safe, after all, what is?”⁶ Many people were surprised when, in 2009, the sovereign debt crisis appeared in Europe. Suddenly, the state itself looked fragile. After the first, disguised default of the Greek state, large corporations in many countries were suddenly considered safer than their countries’ governments: in February 2012, the cost of insuring bonds (through financial instruments called “credit default swaps” or CDSs) was lower for ENI (an Italian multinational corporation in oil and gas), for Telefónica (a Spanish telecom multinational), for Danone (a French food product multinational), for Bayer (a German pharmaceutical multinational), for IBM (an American computer service multinational), than for their respective home governments.⁷

Thus, there is a sovereign risk, a risk that states will not reimburse their debts, as happened often historically, although we seem to have forgotten it. The world of trusted state securities is over. “Sovereign risk is out of the bottle,” wrote The Economist in early 2010. “There is no easy way of putting it back in.”⁸

Many Americans believe that the US government, although glorious and immortal, is not financially safe. A national telephone survey conducted by Rasmussen Reports in May 2012 asked Americans the question: “Which is more likely to occur first, that the federal budget will be balanced or that the federal government will go bankrupt and be unable to pay its debt?” Fifty-one percent of Americans (plus or minus 3 percentage points, statistically true 95% of the time) think that the second alternative will occur first—that the federal government will go bankrupt and be unable to pay its debt. Only 36 percent believe that the federal budget will be balanced first.⁹ One may argue ...

Índice

• Cover
• Title page
• Copyright
• Contents
• List of Charts
• Foreword and Acknowledgments
• Acronyms
• 1   The Genie Out of the Bottle
• 2   Understanding the Public Debt
• 3   Lessons from Europe (and Elsewhere)
• 4   The Hidden Welfare State
• 5   Federal Outlook: The Naked Emperor
• 6   The Emperor’s Praetorians
• 7   The Sovereign’s Bankers
• 8   Reducing Expenditures: Mission Impossible?
• 9   Inflating the Debt Away
• 10   Contagion: When the Emperor Coughs
• 11   The Least Bad of All Possible Worlds
• 12   Opportunities
• Notes
• Bibliography
• Index