In this case, the regime treats its own debts as legitimate while treating those of its predecessors as illegitimate (or at least less legitimate). Eighteenth- century France used a different technique: treating previously defaulted debts as immune to further write-downs, while more recent debts were viewed as fair targets for default because their interest rates were, not surprisingly, considerably higher and could therefore be deemed usurious.

After the Napoleonic War, France finally became a reliable borrower, and one of the main demonstrations of this was honoring the Napoleonic debts in spite of the temptation to repudiate them. It was argued at the time that this was not merely a matter of good faith, but rather an unavoidable price for access to the credit markets on favorable terms as enjoyed by Great Britain.

To my mind, this remains a valid argument. Historically, default almost always had a negative short-term cost – it certainly did so on for France before 1815. The regime always had access to new loans after each bankruptcy; but its access to credit was limited by its previous track record. Attempting to justify its actions by differentiating between types of debt did not fool creditors. They may have continued to lend, but always at rates that factored in the risk of default, and in amounts considerably lower than they were willing to lend to Great Britain.

Just because Ecuador currently experiences a short-term gain will not turn it into a good credit risk. Only paying debts regardless of short-term incentives to default will remove it from the vicious cycle of borrowing and default which has mired Ecuadorian (and Latin American) history since liberation from Spain.

One thing I’m sure of is that anyone can concoct a convincing argument as to why they shouldn’t have to pay back money. At least, an argument that convinces them.

At some point in this crisis, the statement that this is a peculiar and particular event that is self-contained and influences nothing else is going to wear thin. When AIG was bailed out, every business in the country took notice. I can’t believe that other countries aren’t interested in what Ecuador seems to be accomplishing, or that they can’t come up with similar excellent reasons to stiff or trim creditors. We are talking about human beings, after all.

All this makes me suspect that Ecuador wasn’t going to have much access to the market if it paid in full (not when oil revenues are short of what Ecuador needs to sustain its current level of imports/ ecuador needs to go through a deflationary period of adjustment) and probably won’t get much access to the market now.

This was dealt with by charging them a higher rate when the loan was originated.

Overall the loans were a reasonably good deal but payment streams were erratic.

In the last few decades the financial orthodoxy has strongly discouraged this. This has been backed up with an infrastructure including the IMF, etc.

It is not at all clear that the current approach is better than the older one.

There are also real issues where dictators make loan agreements, pocket them money for personal gain, and then a democracy comes in.

Should the new government ruin its credibility with its voters following painful fiscal polices to pay back what many consider illegitimate debts?

The fact that the market reacted this way only suggests that there was indeed a debt overhang and that Correa has managed to restructure obligations in a way that pulls off a deal both for his country AND for potential future investors. With less debt overhang future cashflows that might have gone to pay off those old debts can be more credibly pledged to new investors.

The only danger I see you allude to is that other countries might try to do the same more clumsily in a way that leads markets to irrationally over-react.

But doesn’t the problem then lie with markets that overreact? Should we tell poor developing countries (or under-the-water house mortgage borrowers in the US for that matter) that they should never attempt to restructure past debts because if they do the markets might get spooked in ways that affect others?

We always seem to be willing to bail out or otherwise protect the unsecured creditors because of the fear that ‘panic’ would spread! An element of truth no doubt, but also awfully convenient.