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.