Sovereign Debt Enforcement

Posted on October 26, 2010

1


A Bloomberg article today reports the view that Greece will assuredly default on their sovereign debt within three years. Serendipitously,  from my reading of “This Time is Different” by Carmen Reinhart and Kenneth Rogoff:

In the modern era, however, the idea of using gunboat diplomacy to collect debts seems far-fetched (in most cases). The cost-benefit analysis simply does not warrant governments’ undertaking such huge expenses and risks, especially when borrowing is typically diversified across Europe, Japan, and the United States, making the incentives for an individual country to use military force even weaker.

I’m not a bellicose sort, so this isn’t to say we should start firing 14 inches shells at the Acropolis.  The point here is debt enforcement. In the days of a bipolar world from WWII through the fall of the Soviet Union, mutually-assured destruction prevented military action and propped up unstable nations, maintaining a certain order however shallow it may have been.  In today’s multipolar world, enforcement becomes even more difficult.  Sanctions against Iran mean nothing when Russian sells nuclear generation equipment.  African nations can run to China for help if a western country comes knocking for debt repayment because of their natural resources.

All countries (yes, all) have the internal capital to repay debt if nationalized. Even Zimbabwe with natural resources like gold, iron ore, and nickel could, if directed by their government, stabilize their economy.  In the end, these countries act similarly to individual consumers – continuing to run up debt with no significant fear of retribution.  This feels much like the underwater mortgage borrower who has the assets to pay his mortgage, but chooses the strategic default because it is the best course of action for them personally.  If the lender doesn’t have recourse against personal savings or 401ks, the borrower simply defaults then waits 3-7 years for credit repair then steps right back into the game with a fresh start.

There is precedent internationally for holding countries’ assets as repayment – Iraq oil revenues are recovered (yes, I’m expecting the subsequent maelstrom of comments on this one…).  Without military enforcement, why not require defaulting nations to pledge other capital or hard assets?  By ultimately holding the individuals accountable for outcomes stemming from government decisions, the individuals would inherently hold their lawmakers and government officials more accountable.

Do you think that an electorate, say the United States for example, would allow their government to run up $5 trillion dollars in sovereign debt if they knew they were ultimately liable through means of production?  I’m quite sure that would promote fiscal responsibility.