Rhetoric and reality in Ecuador’s default
Every so often, my web browser will veer far enough to the left to find something like this — a heartfelt defense of Ecuador’s hugely-successful bond default which takes all the domestic political rhetoric at face value.
A lot of the article is simply confused: it frequently elides the distinction between foreign debt and total debt, for instance, and it was clearly not written by anybody who remembers Ecuador’s 2000 debt restructuring, since it calls that deal “unauthorized” when it was anything but. More generally, there’s lots of talk about Ecuador’s foreign debt being “unscrupulous” and “illegal”, not to mention “predatory and inhumane”.
This kind of rhetoric tends to go down well with Ecuador’s voters, but it really doesn’t stand up to scrutiny: if the concept of sovereign debt has any validity at all, then Ecuador’s foreign debt was just as legal as anybody else’s. Besides, given that Ecuador has dollarized, the distinction between illegal foreign debt, on the one hand, and presumably-legal domestic debt, on the other, is very thin: it’s basically just a question of governing law at this point. A decent liability-management office will quite easily play around with the proportion of a country’s debt issued under various different governing laws so as to minimize the country’s total debt-service bill. Certainly there’s no shortage of foreign investors buying domestic debt: do such instruments become illegal the minute that happens, especially if they carry a high coupon?
What Ecuador did in 2009 was essentially just a multi-billion-dollar version of what homeowners are doing in California: walking away from debts because it makes financial sense to do so. There’s always the possibility that any debtor will do such a thing — that’s the reason that credit in general, and Ecuadorean credit in particular, trades at such wide spreads over the risk-free rate. When the cost of default turns negative, countries — like any debtor — are liable to default. That’s simple economics. Trying to gussy that decision up in holier-than-thou rhetoric only serves to obscure the real mechanisms at work here.
I’m interested though to see that many people on the left feel the need to talk at length about the debt being illegal or predatory or whatever: it’s as though they too have bought into the idea that there’s a moral obligation to pay one’s debts, unless those debts are usurious. They don’t have a problem shafting foreign creditors, but they clearly do have an issue with the concept of default, unless it can be accompanied by some kind of moral justification. The economic benefits of defaulting aren’t enough for them: they need to carve out the moral high ground as well. They should beware such overstretch, though, because the moral arguments in this case are very weak: the debt was legal, and Ecuador had the ability to pay it. The only thing it lacked was the willingness to do so.