Among the bogeymen of the modern layman, “default,” or more precisely, “sovereign default,” occupies an important and honored place. This is hardly surprising, since understanding what this actually means is practically impossible for “ordinary people.” The explanations of television economists usually only add fog to an already murky picture. Was there a default or wasn’t there? What are its consequences and why did they occur exactly? Figuring this out can be very difficult.
Our average citizen, accustomed to believing nothing, upon hearing about a default, just in case begins to panic. For example, Ukrainian monetary authorities before the US default that ultimately did not happen called on Ukrainians not to exchange their dollars. Apparently, there were reasons for such appeals. It should be said that such behavior on the part of “ordinary people” is not entirely irrational. And it is caused not only by the complexity of economic processes that “ordinary people” cannot understand, but also by conceptual confusion, which, however, arose far from by chance.
We will discuss this confusion, its consequences, and a little about default itself in this column.
There is nothing special or unusual about a “default” or “sovereign default.” Simply put, it is the bankruptcy of a state—that is, the inability to meet its obligations. There is nothing new in this phenomenon—rulers, and then states, have been constantly plagued by their inability to pay their bills throughout history. The United States itself experienced a default twice. The first time, the default lasted from 1862 to 1879 and was caused by the government’s inability to pay on the “greenbacks” issued during the Civil War. The second occurred in 1935, when Roosevelt decided that gold would cost not $20 per ounce, but $35. Moreover, only foreigners could exchange their government bonds for gold; bondholders (that is, holders of obligations on government debt) in the United States itself could only receive paper dollars, which were now worth almost half as much.
Default situations occurred even more frequently in other countries. So why has attention to sovereign defaults become so acute now? The thing is this: Until a certain point, games with the state were simply one form of speculation among many. People lending money to Uncle Sam or any other government had their reasons for doing so, but the consequences of their actions (and the government’s inability to pay) concerned largely only themselves. However, after the final monopolization of money and the destruction of the gold standard, all this changed. Now states gained full control over the monetary system and the ability to produce money in unlimited quantities. Their debts now led to consequences that extended far beyond creditors. More precisely, these consequences became far more irreversible for everyone.
Let me remind you that states do not produce any value that would be voluntarily exchanged on the market. Simply put, they have nothing “of their own.” States borrow other people’s money and repay with other people’s money as well—the money of taxpayers. Therefore, in general, the growth of state debts and other obligations leads to higher taxes. In fact, this is how it has happened historically—the aggregate tax rate constantly grows along with state expenditures. However, taxes have one unpleasant feature for the state—they can be evaded. Monetary monopoly solves this problem. There is no escaping devaluation or inflation.
The intuitive understanding of this circumstance is one of the reasons for the attention paid to defaults. Actually, the problem is not the default itself, but the state’s behavior in resolving this situation. If it is expected that the “solution to the problem” will be devaluation or firing up the printing press, then there is every reason for panic and for taking protective measures.
The second circumstance I want to mention is the change in perceptions of the state that occurred simultaneously with its acquisition of a monopoly on money and other events associated with the state’s expanding role in our lives. Today we live in a world where the informational context includes the notion of the state as an enterprise. This notion began to take shape with the German “historical school” in economics and finally crystallized into dominance in the mid-20th century. It views the state as the main agent and, in essence, the owner of the “national economy.” The goal of the state is to increase “profit,” that is, “the steady growth of workers’ well-being.” This “profit” began to be measured at some point by GDP growth—an indicator that became universal for the political economy mainstream. If people perceive the state as an enterprise, it is not surprising that they fear default as they would fear the bankruptcy of the company they work for.
It is at this point that the substitution of meaning I mentioned at the beginning occurred. Because in reality, the state is not an enterprise—it produces nothing, incurs no costs, and so on. The state simply appropriates taxpayers’ money. The notion of the state as an enterprise, and of GDP as an indicator of its efficiency, are erroneous, but very useful for the state itself—it ensures its legitimacy and self-reproduction. However, games with state debts and defaults are destined to play a cruel joke with this notion. If the state is an “economy,” then the concepts of profit and efficiency apply to it. This directly leads to the conclusion that it is liable for obligations and can go bankrupt, be sold in whole or in parts, taken under management, and so on. An inefficient enterprise should be liquidated and transferred to an owner who will manage it better. State debts are growing everywhere, the fiat money system is bursting at the seams—therefore, sovereign defaults will arise more and more often. This means that the question will be asked more and more often: If this state-enterprise cannot handle the task, why aren’t we selling it?
Both solutions that follow from this question are unfavorable for states. The first solution—to sell—is hardly feasible. States are incapable not only of selling off some of their functions, they are incapable (as the US example clearly demonstrates) of simply cutting their expenses. The second solution—to renounce the role of enterprise—is more preferable, but far more unpredictable than the first. Because if the state is not an enterprise whose goal is the “steady increase in the percentage of butterfat in butter,” then what is it and, most importantly, why does it exist? The state is left with the role of some sacred force, a myth, and an object of faith. However, in our rational age, hardly anyone would agree that a myth and object of faith should engage in the forced confiscation of property from both believers and non-believers, impose its rules indiscriminately on everyone, monitor them itself, and provide “services” from which it is impossible to opt out. As long as it is about butterfat, all these “nuances” are perceived as the price of progress, but if there is no more butterfat, then uncomfortable questions arise.
In general, states have gotten into quite an unpleasant situation—following the logic of an enterprise logically leads to the demand to sell them at auction, and abandoning this logic deprives them of legitimacy. Of course, the “world elite,” whatever or whoever is understood by these words, is already working on the problem. For example, the word “default” instead of “bankruptcy” already nicely leads us away from understanding and obscures the meaning. There are other ideas, such as abandoning GDP growth as a universal state product and replacing it with a “happiness index.” So far this idea exists at the level of bureaucratic freaks from the UN, but who knows, who knows…
In general, returning to conceptual confusion and attitudes toward sovereign default, the following conclusions can be drawn:
“Sovereign default” is an analog of bankruptcy, but does not yet have mechanisms for legitimate resolution of the conflict—unlike enterprises, for a state, bankruptcy does not mean liquidation or sale of the debtor, nor forced reorganization, nor transition to external management; often state bankruptcies do not even lead to the resignation of management.
Only and exclusively the taxpayer pays for both the policy that leads to default and the elimination of its consequences.
The degree of catastrophic impact of a default depends on political circumstances—that is, on the borrower’s relations with creditors. If the latter are not interested in the borrower’s collapse, then the fall will be softer. However, I repeat—in any case, the taxpayer pays.
Since states are incapable of serious policy changes and always prefer short-term interests to long-term ones, sovereign defaults will occur with increasing frequency. This will have not only economic and political (in the case of the dollar’s collapse, for example) consequences, but also worldview consequences associated with changing perceptions of the state and the need for it.