Opinion

Edward Hadas

Mega sovereign writeoff could work

By Edward Hadas
February 12, 2014

A massive sovereign debt reduction is the right way to reduce the ridiculously high indebtedness of governments. The idea might sound crazy, but it makes economic sense, and could be done, albeit after some serious preparatory work.

Many rich country governments have been borrowing excessively in recent years. In 1991, when the calculations from the International Monetary Fund started, gross government debt of advanced economies was 60 percent of GDP. This year it is expected to be 108 percent of GDP, or about $51 trillion.

The current level is much too high for the overall economic good. Heavily indebted governments spend too much of their tax revenue on interest payments and spend too much time trying to placate bond buyers, who rarely support useful long-term investments. Rumours of possible default can spark a financial crisis. And the excessive supply of sovereign obligations encourages parasitic speculation. The economically pointless trades of supposedly risk-free government debt pay much of the high salaries at investment banks.

Governments have brought the problem on themselves. The underlying issue is the longstanding refusal to match taxes to expenditures, especially during years of peace and prosperity. Governments resort to borrowing to bridge the gap, because politicians like to appear to give more than they take. However, someone must pay – debt is only a temporary substitute for a tax. Bondholders may think they have made an investment in a financial asset, but in reality they are standing in for taxpayers.

Writedowns make the reality clear. The loss converts some of the government bond’s purported value into what it should have been in the first place – a tax. Foreign bondholders simply lose out, since they would not have paid domestic taxes. Some domestic lenders may also be treated unfairly, even after considering the taxes they would have paid if governments had run balanced budgets.

The damage is regrettable, but needs to be set against the gains that would go with a massive debt writedown. A cut of about $25 trillion, a 50 percent reduction, would let governments throw off the suffocating debt blanket.

The idea would appal most mainstream economists. They agree that government debts are currently too high. Yet they do not want any writedowns, let alone massive ones. The subtitle of a 2010 Staff Position Note from the IMF is typical: “Default in Today’s Advanced Economies: Unnecessary, Undesirable, and Unlikely”. The standard prescription is many years of sound government finance. That technique can succeed, but only if there is an implausibly long period of political restraint and reasonably strong economic growth.

Massive debt forgiveness would solve the problem quickly and safely – if they are done right. There are three plausible ways to get rid of large quantities of unwanted bonds.

The first is through a large writedown. Basically, governments would re-issue all their debt with half the face value. For this “Reissue Day” approach to work, careful preparations and international agreement are required. Disaster can be avoided, although it would be tricky. A powerful propaganda campaign is a prerequisite, as is a clear plan to recapitalise banks, in part with new government funds. And all countries must agree to recognise losses on their holdings of foreign government sooner rather than later.

Alternatively, instead of writing down debts, governments could inflate up wages and prices. For example, a mandatory one-time doubling of all wages would quickly almost double nominal GDP, mechanically almost halving the economic weight of the government debt burden. The “Rescale Payday” would be technically and legally complex, a bit like dividing one currency into two. Forethought and flexibility would be mandatory.

Finally, governments could print debts away. As borrowings mature, they would be redeemed with newly created money. The monetisation would be followed quickly by new taxes which would reduce the expanded money supply to non-inflationary levels. The reclaimed funds would then be destroyed. The round trip sounds complicated, but the separation of bond redemption from tax recuperation would help governments arrange the details of the “Less for More Exchange” to allocate losses as fairly as possible.

I doubt that any of these techniques will be tried out, for both good and bad reasons. On the good side, there is the ethical concern about breaking financial contracts, the risk of social tension after a sudden redesign of a key part of the monetary system and the innumerable diabolical details. On the bad side are mainstream economists’ lack of intellectual courage and the inability of politicians to organise something as daring as the monetary equivalent of post-war reconstruction.

It is almost always easier to muddle along than to do something bold. In this case, though, the costs of inaction, or of the painfully small and slow writedowns of euro zone sovereign debts, are quite high. In an over-leveraged world, default is actually the safest default option.

Comments
9 comments so far | RSS Comments RSS

In the United States investment transactions total $500 trillion dollars per year. A one year transaction tax of 0.3% would pay off the federal debt.

Posted by jprose | Report as abusive
 

“Governments have brought the problem on themselves. The underlying issue is the longstanding refusal to match taxes to expenditures, especially during years of peace and prosperity.” Yep, and there is no reason whatsoever to believe that any of the many reasons governments have done this have changed over time.

“…the calculations from the International Monetary Fund started, …gross government debt of advanced economies…is much too high for the overall economic good.” “The standard prescription is many years of sound government finance. That technique can succeed, but only if there is an implausibly long period of political restraint and reasonably strong economic growth.” Again, you state the obvious.

“There are three plausible ways to get rid of large quantities of unwanted bonds.

The first is through a large writedown.” And, after that is done, what fool would step forward AGAIN to ever again “invest” in bonds backed only by government promises?

“Alternatively, instead of writing down debts, governments could inflate up wages and prices.” That would give a considerable windfall for all whose income is indexed. Everyone else becomes a victim and there is little precedent as to precisely what would then happen to the “well being” of the majority of currently employed American workers whose income is NOT indexed. Already government is inflating the currency and attempting to dilute the index by which purchasing parity is supposed to be guaranteed those on disability and Social Security.

“Finally, governments could print debts away. As borrowings mature, they would be redeemed with newly created money. The monetisation would be followed quickly by new taxes which would reduce the expanded money supply to non-inflationary levels. The reclaimed funds would then be destroyed.” Hey, America has been doing this since WW II. A car that cost me $3600 in 1970 today costs $22,000+, and the income tax rates on that 22,000 are a lot more than they were on that 3600. When America is already on the wrong road, the idea of “going faster” as a solution is nothing less that frightening.

Yes, the ethics and social tensions here would demand a level of intelligence, competence and political will unheard of in either American political leadership (oxymoron) or the bureaucracy that moves the money here and there.

Eventually there WILL be a default in some form, the sole remaining questions being “when” and “who loses most”. No question as to who will come out best, either. The American political leadership (oxymoron) and the bureaucracy ALWAYS come out on top.

Posted by OneOfTheSheep | Report as abusive
 

The biggest single debt imbalance (US-China) is already a result of ‘national decree’ in the form of China fixing it currency level. Why not fix one decree with another, in the form of a write-off.

Posted by BidnisMan | Report as abusive
 

If a family member came to you and said,
“I know I’ve been on an alcohol-binge for the last 10–15 years, and I know I’m in debt by 1×–2× annual salary with non-discretionary outgoings at 90%–95% of gross earnings; but I’ve decided it’s time to call a halt to it: it’s bringing the whole family down. I need your help. I want you to pay down 50% of my debt, and then I’ll turn my life around and start paying down the remainder.”
— What would you say if you had spent the last 10–15 years scrimping and saving to keep your head above water and stay out of debt? Would your answer be different if you were wealthy and would find it easy to help with the money? (You don’t have to give a straight yes-or-no answer…) My response in every case would be:
“Show me that you’re serious, quit the booze, reform your expenditures; and then we’ll talk about it again: if I see that you’re serious, then I’ll start to help you, and continue for as long as I am able and for as long as I see progress on your part.”

Posted by matthewslyman | Report as abusive
 

…Take a different approach, and irrespective of the impressions the debtor tries to give in public; their private response will be predictable:
“PARTAAAAYYYYYYYY!!!!!!!”

Posted by matthewslyman | Report as abusive
 

You’ve got to be kidding.

Posted by Bob9999 | Report as abusive
 

this is a prank article, right?!

Posted by dankosh | Report as abusive
 

Default of government debt is a ticket to third world status. The author assumes that a debt near the GDP is unsustainable. Many people assume that based on ideology alone, a false analogy to household debt, or on the falsified Reinhart-Rogoff study, but it is only an assumption.

Posted by QuietThinker | Report as abusive
 

only spend what the government dares to tax, isn’t that the answer.

Posted by dankosh | Report as abusive
 

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