Sovereign Debt E-Book
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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Robert W. Kolb Series
- Sprache: Englisch
An intelligent analysis of the dangers, opportunities, and consequences of global sovereign debt Sovereign debt is growing internationally at a terrifying rate, as nations seek to prop up their collapsing economies. One only needs to look at the sovereign risk pressures faced by Greece, Spain, and Ireland to get an idea of how big this problem has become. Understanding this dilemma is now more important than ever, that's why Robert Kolb has compiled Sovereign Debt. With this book as your guide, you'll gain a better perspective on the essential issues surrounding sovereign debt and default through discussions of national defaults, systemic risk, associated costs, and much more. Historical studies are also included to provide a realistic framework of reference. * Contains up-to-date research and analysis on sovereign debt from today's leading practitioners and academics * Details the dangers of defaults and their associated systemic risks * Explores the past, present, and future of sovereign debt The repercussions of a national default are all-encompassing as global markets are intricately interwoven in the modern world. Sovereign Debt examines what it will take to overcome the challenges of this market and how you can deal with the uncertainty surrounding it.
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Veröffentlichungsjahr: 2011
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Contents
Cover
Series
Title Page
Copyright
Dedication
Introduction
SOVEREIGN DEBT: A PIVOTAL FACTOR IN WORLD AFFAIRS
ABOUT THE TEXT
NOTES
ABOUT THE EDITOR
Acknowledgments
Part I: The Political Economy of Sovereign Debt
Chapter 1: Sovereign Debt
REPUTATIONAL EXPLANATIONS
BEYOND REPUTATIONAL EXPLANATIONS FOR SOVEREIGN DEBT
CREDITOR SANCTIONS AND SOVEREIGN DEFAULTS
CONCLUSION
NOTES
Chapter 2: The Institutional Determinants of Debt Intolerance
THE ROLE OF POLITICAL INSTITUTIONS
THE ROLE OF MONETARY INSTITUTIONS
NOTES
ABOUT THE AUTHORS
Chapter 3: Output Costs of Sovereign Default
COSTS OF DEBT CRISES
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 4: Spillovers of Sovereign Default Risk
LITERATURE REVIEW: SOVEREIGN DEFAULT RISK AND CORPORATE ACCESS TO FINANCE
DATA AND EMPIRICAL STRATEGY
MEASURING SOVEREIGN RISK AND DEFAULT
SUMMARY OF RESULTS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 5: Sovereign Debt Problems and Policy Gambles
BACKGROUND
TESTING THE THEORY OF POLITICAL GAMBLING FOR REDEMPTION
CONCLUSION
ABOUT THE AUTHOR
Chapter 6: Sovereign Debt and the Resource Curse
SOME PIECES OF THE PUZZLE FROM THE PREVIOUS LITERATURE
MECHANISM AND EMPIRICAL RESULTS
CONCLUSION AND POLICY IMPLICATIONS
NOTE
ABOUT THE AUTHORS
Chapter 7: Sovereign Debt and Military Conflict
SOVEREIGN DEBT AS A PERMISSIVE CAUSE OF WAR
SOVEREIGN DEBT AS A CONSTRAINT ON BELLIGERENCE
CONCLUSION
NOTES
ABOUT THE AUTHOR
Part II: Making Sovereign Debt Work
Chapter 8: Fiscal Policy, Government Institutions, and Sovereign Creditworthiness
ANALYTICAL FRAMEWORK
KEY FINDINGS
POLICY IMPLICATIONS
ABOUT THE AUTHORS
Chapter 9: Corruption and Creditworthiness
NOTES
ABOUT THE AUTHORS
Chapter 10: Institutions, Financial Integration, and Complementarity
INTRODUCTION
INSTITUTIONS AND PUBLIC DEFAULT RISK
CAPITAL FLOWS, PUBLIC DEFAULTS, AND COMPLEMENTARITY
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 11: Loans versus Bonds
LARGER LENDERS EARN MORE
IDIOSYNCRATIC LIQUIDITY SHOCKS AND THE RETURN PREMIUM
ARE BANKS SPECIAL LENDERS?
CONCLUSION
NOTE
ABOUT THE AUTHORS
Chapter 12: First-Time Sovereign Bond Issuers
RECENT EXPERIENCE
BENEFITS AND RISKS OF INTERNATIONAL ISSUANCE
MAIN ISSUES TO CONSIDER WHEN PLANNING AN INITIAL INTERNATIONAL BOND ISSUE
COMMON MISTAKES OF FIRST-TIME ISSUERS
NOTES
ABOUT THE AUTHORS
Chapter 13: A Note on Sovereign Debt Auctions
NOTES
ABOUT THE AUTHORS
Chapter 14: Pension Reform and Sovereign Credit Standing
NOTES
ABOUT THE AUTHORS
Part III: Sovereign Defaults, Restructurings, and the Resumption of Borrowing
Chapter 15: Understanding Sovereign Default
SOVEREIGN DEFAULTS
COSTS OF SOVEREIGN DEFAULTS
DETERMINANTS OF SOVEREIGN DEFAULTS
BORROWING COSTS
BUSINESS CYCLES IN EMERGING ECONOMIES AND SOVEREIGN DEFAULT
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 16: Are Sovereign Defaulters Punished?
DATA AND RESULTS
ABOUT THE AUTHORS
Chapter 17: Supersanctions and Sovereign Debt Repayment
ENFORCEMENT MECHANISMS
FISCAL HOUSE ARREST
GUNBOAT DIPLOMACY
EFFECTS OF SUPERSANCTIONS
NOTES
ABOUT THE AUTHORS
Chapter 18: Debt Restructuring Delays
MEASURING DEFAULT AND NEGOTIATION EPISODES
THE DEBT RESTRUCTURING PROCESS: THREE PHASES
EVIDENCE ON CREDITOR LITIGATION AND HOLDOUTS
SUMMARY
APPENDIX: THE DATABASE ON RESTRUCTURING DELAYS
NOTE
ABOUT THE AUTHOR
Chapter 19: IMF Interventions in Sovereign Debt Restructurings
OFFICIAL POLICY
EXPERIENCE WITH PAST RESTRUCTURINGS: STYLIZED FACTS AND IMF’S INVOLVEMENT
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 20: Resuming Lending to Countries Following a Sovereign Debt Crisis
BEYOND THE ISSUE OF REPUTATION
DEMAND AND SUPPLY FACTORS
WHAT DOES THE EVIDENCE SAY?
CONCLUSION
ABOUT THE AUTHOR
Part IV: Legal and Contractual Dimensions of Restructurings and Defaults
Chapter 21: A Code of Conduct for Sovereign Debt Restructuring
THE ROLE OF A CODE OF CONDUCT IN THE INTERNATIONAL FINANCIAL SYSTEM
OBJECTIVES OF A CODE OF CONDUCT
FEATURES OF A CODE OF CONDUCT
THE ADVANTAGES AND DISADVANTAGES OF A CODE OF CONDUCT
CONCLUSION
NOTE
ABOUT THE AUTHOR
Chapter 22: Governing Law of Sovereign Bonds and Legal Enforcement
NATIONAL LAWS: AD HOC INTERNATIONAL LEGAL FRAMES
GOVERNING LAW AND CREDIT CONSTRAINTS
CONCLUSION
NOTES
ABOUT THE AUTHOR
Chapter 23: Sovereign Debt Restructuring
WHY DO SOVEREIGNS PAY?
KEY ASPECTS OF THE ARGENTINE DEBT RESTRUCTURING
JUDGE-MEDIATED DEBT RESTRUCTURING: FROM DEFAULT TO SWAP
CACS, COURTS, AND CREDITOR COMMITTEES
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 24: Sovereign Debt Documentation and the Pari Passu Clause
THE ELLIOTT CASE
INTERPRETATION OF THE PARI PASSU CLAUSE
EXOGENOUS REASONING
THE SHIFT FROM UNANIMOUS ACTION CLAUSES TO COLLECTIVE ACTION CLAUSES
THE SHIFT FROM FISCAL AGENT TO TRUSTEE WITH SOLE ENFORCEMENT POWERS
REFLECTING ON THE EXOGENOUS FACTORS
CONCLUSION
NOTES
ABOUT THE AUTHOR
Chapter 25: Collective Action Clauses in Sovereign Bonds
BACKGROUND
INVESTORS’ PERSPECTIVE
BORROWERS’ PERSPECTIVE
CONCLUSION
ABOUT THE AUTHOR
Chapter 26: Sovereignty, Legitimacy, and Creditworthiness
THE HIDDEN FOUNDATIONS OF SOVEREIGN LENDING
SOVEREIGNTY AND CREDITWORTHINESS
CONCLUSION
NOTES
ABOUT THE AUTHOR
Chapter 27: Odious Debts or Odious Regimes?
PRACTICAL OBSTACLES AND ALTERNATIVE APPROACHES
ODIOUS REGIMES: A DEFINITION
REMEDIES AND THE ROLE OF THE U.N. AND IMF AS DECISION MAKERS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 28: Insolvency Principles
NOTES
ABOUT THE AUTHOR
Part V: Historical Perspectives
Chapter 29: The Baring Crisis and the Great Latin American Meltdown of the 1890s
THE BARING CRISIS OF 1890
MOVEMENTS IN EMERGING MARKET YIELD SPREADS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 30: How Government Bond Yields Reflect Wartime Events
EMPIRICAL METHOD AND DATA
ESTIMATING STRUCTURAL BREAKS IN NORDIC SOVEREIGN YIELDS
COMPARING THE VIEWS OF HISTORIANS AND MARKETS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 31: How Important Are the Political Costs of Domestic Default?
INSTITUTIONAL SETTING AND DATA
EMPIRICAL ANALYSIS
CONCLUSION
NOTES
ABOUT THE AUTHOR
Chapter 32: Emerging Market Spreads at the Turn of the Twenty-First Century
NOTES
ABOUT THE AUTHOR
Part VI: Sovereign Debt in Emerging Markets
Chapter 33: Sovereign Default Risk and Implications for Fiscal Policy
ABOUT THE AUTHORS
Chapter 34: Default Traps
INTRODUCTION
EXPLAINING SERIAL DEFAULT
EMPIRICAL EVIDENCE
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 35: Self-Fulfilling and Self-Enforcing Debt Crises
DATA SET
CONCLUSION
ABOUT THE AUTHORS
Chapter 36: The Impact of Economic and Political Factors on Sovereign Credit Ratings
INTRODUCTION
MAIN RESULTS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 37: Sovereign Bond Spreads in the New European Union Countries
WHAT EXPLAINS GOVERNMENT BOND SPREADS? A MODEL AND EMPIRICAL RESULTS
THE ROLE OF MACROECONOMIC AND FISCAL FUNDAMENTALS
POLICY MEASURES
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 38: Can Sovereign Credit Ratings Promote Financial Sector Development and Capital Inflows to Emerging Markets?
NOTE
ABOUT THE AUTHORS
Chapter 39: Country Debt Default Probabilities in Emerging Markets
DEBT RESCHEDULING PROBABILITY MODEL
EMPIRICAL VERSUS CRAS’ PROBABILITIES OF EMERGING MARKETS SOVEREIGN DEBT RESCHEDULING
IMPLICATIONS
NOTES
ABOUT THE AUTHORS
Chapter 40: The International Stock Market Impact of Sovereign Debt Ratings News
RESEARCH DESIGN
EMPIRICAL RESULTS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Part VII: Sovereign Debt and Financial Crises
Chapter 41: Equity Market Contagion and Co-Movement
ABOUT THE AUTHORS
Chapter 42: An Insolvency Procedure for Sovereign States
REASONS FOR ESTABLISHING AN INSOLVENCY PROCEDURE FOR SOVEREIGN STATES
THE MAIN FEATURES OF AN INSOLVENCY PROCEDURE
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 43: From Banking to Sovereign Debt Crisis in Europe
THEORETICAL LINKAGES AND EMPIRICAL EVIDENCE
NOTES
ABOUT THE AUTHORS
Chapter 44: From Financial Crisis to Sovereign Risk
NOTES
ABOUT THE AUTHORS
Chapter 45: Sovereign Spreads and Perceived Risk of Default Revisited
INTRODUCTION
CONCEPTUAL FRAMEWORK: A PROPOSAL
FURTHER RESEARCH AND POLICY IMPLICATIONS
ABOUT THE AUTHORS
Chapter 46: What Explains the Surge in Euro Area Sovereign Spreads During the Financial Crisis of 2007–2009?
THE EMPIRICAL EVIDENCE
RISK TRANSFER FROM THE PRIVATE TO THE PUBLIC SECTOR: THE ROLE OF BANK RESCUE PACKAGES
ROBUSTNESS CHECKS AND RELATIVE CONTRIBUTION OF FACTORS
POLICY LESSONS
NOTES
ABOUT THE AUTHORS
Chapter 47: Euro Area Sovereign Risk During the Crisis
DISSECTING COMMON RISK
EXPLAINING DEVELOPMENTS IN EURO AREA SOVEREIGN RISK DURING THE CRISIS
CONCLUSION
NOTES
ABOUT THE AUTHORS
Chapter 48: Facing the Debt Challenge of Countries That Are “Too Big To Fail”
TOO BIG TO FAIL
CONCLUSION
NOTES
ABOUT THE AUTHOR
Index
The Robert W. Kolb Series in Finance provides a comprehensive view of the field of finance in all of its variety and complexity. The series is projected to include approximately 65 volumes covering all major topics and specializations in finance, ranging from investments, to corporate finance, to financial institutions. Each volume in the Kolb Series in Finance consists of new articles especially written for the volume.
Each volume is edited by a specialist in a particular area of finance, who develops the volume outline and commissions articles by the world's experts in that particular field of finance. Each volume includes an editor's introduction and approximately thirty articles to fully describe the current state of financial research and practice in a particular area of finance.
The essays in each volume are intended for practicing finance professionals, graduate students, and advanced undergraduate students. The goal of each volume is to encapsulate the current state of knowledge in a particular area of finance so that the reader can quickly achieve a mastery of that special area of finance.
Please visit www.wiley.com/go/kolbseries to learn about recent and forthcoming titles in the Kolb Series.
Copyright © 2011 by John Wiley & Sons, Inc. All rights reserved.
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Library of Congress Cataloging-in-Publication Data:
Sovereign debt : from safety to default / Robert W. Kolb, editor. p. cm. – (Robert W. Kolb series in finance) Includes bibliographical references and index. ISBN 978-0-470-92239-2 (cloth); ISBN 978-1-118-01753-1 (ebk); ISBN 978-1-118-01754-8 (ebk); ISBN 978-1-118-01755-5 (ebk) 1. Debts, Public. I. Kolb, Robert W., 1949- HJ8015.S68 2011 336.3′4–dc22 2010043306
To Lori, my sovereign
Introduction
Sovereign debt—borrowing by governments—has been a feature of world finance since antiquity. By its very nature, governmental borrowing is somewhat arcane and usually takes place beyond the purview of the typical citizen's personal interest. However, at all times, sovereign borrowing affects everyone in society—after all, when a government borrows it hands a piece of the obligation to every taxpayer. Normally obscure, sovereign debt sometimes suddenly seizes headlines and becomes spectacularly important for everyone in a society under stress. This volume offers the reader a comprehensive understanding of how sovereign debt works and how it affects the world today. Problems with sovereign debt shape the course of wars and help to determine national boundaries. In times of crisis, the management of sovereign debt even has an impact on the type and amount of food that people consume.
Today, issues of sovereign debt are more important than ever, and these concerns promise to reach into the lives of all of us to an unprecedented degree in the future. The last 15 years have witnessed rather spectacular events related to sovereign debt, debt crises, and default. In 1997, the Asian financial crisis swept across East Asia with devastating effects on economic growth and consumption in Thailand, South Korea, and Indonesia, and also afflicted Hong Kong, Malaysia, Laos, and the Philippines. Consumption plummeted in Thailand, and economic growth in the Philippines fell to nearly zero. At the same time, events forced Indonesia to devalue the rupiah. Widespread rioting followed, and Indonesia's government fell after decades of rule.
The Asian financial crisis led swiftly to a default by Russia, leading the International Monetary Fund and the World Bank to respond with a $23 billion bailout. Russia's nearby trading partners, many former Soviet republics, suffered considerably as well. Belarus and Ukraine sharply devalued their currencies, and in Uzbekistan the government placed restrictions on the sale of food to avoid panic. For their part, the Baltic states of Estonia, Latvia, and Lithuania fell into recession.
Having swept from Asia to Russia in a short period, financial distress came quickly to the United States with a dramatic effect on the hedge fund Long-Term Capital Management (LTCM), which was heavily invested in the Russian ruble. Events quickly proved that LTCM was pivotal in the global financial system, revealing a degree of interconnectedness that had previously been unthinkable. Policy makers soon realized that the collapse of LTCM threatened the entire financial system, and the Federal Reserve Bank of New York organized a bailout financed by $3.5 billion from the largest financial firms on Wall Street. The proud LTCM, which featured principals who had won the Nobel prize in economics, completely collapsed.1 The aftermath of these crises revealed to all attentive observers a new world financial structure that now possessed an astounding degree of interconnectedness—a world in which financial distress could fly as quickly as rumor.2
Against the background of the late 1990s, it was easier during the time from 2007 to 2009 to comprehend the speed with which financial distress could travel from market to market and from firm to firm, even if the magnitude of that distress shocked virtually everyone, from Wall Street titan to the small-holding pensioner. These events have set a new stage for sovereign debt in a globalized financial world—a world in which a financial hiccup in one region, market, country, or company can cause convulsions in an economy previously thought to have been quite remote from the original point of distress.
SOVEREIGN DEBT: A PIVOTAL FACTOR IN WORLD AFFAIRS
With the breakup of the Soviet Union in the early 1990s, some observers saw an ultimate and permanent triumph of liberal democracies with an “end of history” that initiated a stable future. This view was short-lived, and now others see an enduring “clash of civilizations,” or at least a “return of history and the end of dreams.”3 The attacks of September 11, 2001, certainly provide a general awakening to conflict at the level of civilizations, while the collapse of the dot-com bubble and the financial crisis of 2007–2009 has made us all aware that we now live in a new world of finance.
But we also live in a world being radically transformed by the rise of new economic, political, and military powers. At least one leading economist foresees China as quickly becoming the country with the world's largest GDP and succeeding in establishing an economic hegemony over the rest of the world.4 With a military that is still little threat to that of the United States, China has just passed the United States in total number of warships. While some concede that the United States and the Western democracies generally face a slowly developing eclipse, others speculate that complex societies may be faced with sudden collapse and specifically suggest that such rapid dissolution of world standing might be a near-term fate for the United States.5
While any reasoned reading of geopolitical tea leaves suggests that the West faces huge challenges ranging from an aging population to a loss of economic and military primacy, it should be clear to all that much of the West's ability to navigate the next decades will depend to a considerable degree on its financial strength. In the United States, the collapse of home prices, the dislocations of the ensuing Great Recession, the fiscal plight of many state governments, and the growing furor over economic management at the federal level all make the financial challenges we face evident to almost everyone.
These challenges face the Western democracies generally. Exhibit I.1 shows the level of total societal debt—the sum of the debt of governments, households, financial institutions, and nonfinancial businesses—for the leading economic nations of the world. By this measure, the United Kingdom and Japan are far and away the most heavily indebted societies, with total debt exceeding more than four years of the entire gross domestic product of these nations. The United States is only in the middle rank of these nations with slightly less than 300 percent of GDP as the burden of its societal debt. Notably, the large developing nations—the BRIC countries of Brazil, Russia, India, and China—carry the lowest debt burdens.6
Exhibit I.1 Total Societal Debt as a Percentage of GDP
Source: McKinsey & Company, “Debt and Deleveraging: The Global Credit Bubble and Its Economic Consequences,” January 2010, 20.
Exhibit I.2 Sovereign Debt as a Percentage of GDP
Source: McKinsey & Company, “Debt and Deleveraging: The Global Credit Bubble and Its Economic Consequences,” January 2010, 20.
For this same collection of nations, the rank ordering of sovereign debt as a percentage of GDP differs substantially from the ranking for total societal debt, as Exhibit I.2 shows. Japan's sovereign debt burden is almost twice as large relative to GDP as Italy's, which is second. Again, the United States falls in the middle rank of these countries. The BRIC nations, with uniformly lower levels of total societal debt, are diverse with respect to their sovereign debt levels. Most notably, Russia has very little sovereign debt, no doubt due to its sovereign default in 1998 and its subsequent exclusion from sovereign borrowing.
In the United States, the level of sovereign debt has varied dramatically over the years, showing a marked tendency to rise during times of war and to fall during times of peace. Exhibit I.3 shows the fluctuating level of sovereign debt for the United States from 1800 to 2010. The graph shows a clear pattern of debt that rose during periods of war: the Civil War, World War I, and during and immediately following World War II. The current debt level is second only to the level that resulted from World War II. In the United States, this unprecedentedly high level of sovereign debt in a period of relative peace, coupled with high levels of personal debt are two principal sources of the economic concern that resulted in the political realignments of the mid-term elections of 2010 and continue to threaten (or promise) continuing substantial political repercussions.
Exhibit I.3 U.S. Federal Debt as a Percentage of GDP
Source: www.usgovernmentspending.com/federal_debt_chart.html. Accessed September 1, 2010.
Concerns about sovereign debt are now widespread and intense. As a survey of sovereign debt conditions shows, the United States remains in a strong position as a borrower, despite having suffered a large worsening of fiscal conditions in a time of relative peace. Compare, for instance, the list of the world's riskiest sovereign borrowers, topped by Venezuela, as Exhibit I.4 shows. There is little doubt that Venezuela is capable of repaying its debts, given its substantial oil wealth. However, political posturing by an unreliable and perhaps unstable dictator there makes the honoring of Venezuela's debts a less-than-safe proposition. For Greece, the second riskiest sovereign borrower, the problem is quite otherwise. Greece worked itself into a bad situation through years of unsustainably generous social payments, a succession of governments that permitted themselves to be hostage to powerful unions, and a society committed to tax avoidance under the aegis of a government with poor tax-collection abilities. In late 2010, Credit Market Analysts, Ltd., the source of these rankings, gave both Venezuela and Greece a higher than 50 percent chance of default sometime during the next five years. Exhibit I.5 shows the most reliable borrowers, with Norway being the most likely to repay in full, due in no small part to its vast oil revenues, combined with its very substantial sovereign wealth fund. Despite the excited headlines, the United States remains a very reliable credit risk, ranked third for reliability by Credit Market Analysts, Ltd.
Exhibit I.4 The World's Riskiest Sovereign Borrowers (Ranked from Riskiest to Less Risky)
Source: Credit Market Analysts, Ltd., “Global Sovereign Credit Risk Report,” Second Quarter, 2010, 4.
1Venezuela2Greece3Argentina4Pakistan5Ukraine6Dubai7Iraq8Romania9Latvia10BulgariaExhibit I.5 The World's Most Reliable Sovereign Borrowers (Ranked from Most Reliable to Least Reliable)
Source: Credit Market Analysts, Ltd., “Global Sovereign Credit Risk Report,” Second Quarter, 2010, 5.
1Norway2Finland3USA4Denmark5Sweden6Germany7Switzerland8Netherlands9Hong10AustraliaIn late 2010, we appear to have reached the aftermath of the financial crisis of 2007–2009 as the Great Recession seems to recede or at least to moderate in its intensity. Nonetheless, the financial crisis and recession have left a very serious situation. This has been exposed by the crisis that rocked the European Union nations in 2010 as concern mounted over the economic viability of entire nations, the so-called PIIGS—Portugal, Ireland, Italy, Greece, and Spain—with Greece being the focal point of most intense concern. At one point in 2010, insuring Greek sovereign bonds against default for a single year exceeded 11 percent of the promised payment amount. The parlous state of world finance led the Bank for International Settlements to judge: “Fears of sovereign risk threaten to derail financial recovery.”7 However, comparison of sovereign debt levels with previous periods show them only as being high, not necessarily as being disastrous.
The elevated, but not necessarily dramatic, level of sovereign debt fails to disclose the whole picture, however. Some countries with the largest economies that have occupied positions of world leadership for decades are saddled not only with large levels of sovereign debt, but large levels of total societal debt, plus structural budget deficits they seem unwilling to correct. Exhibit I.1 has already shown the high levels of societal debt for Japan, the United Kingdom, some other leading EU countries and the United States. However, these countries also have chronic national budget deficits. These countries have been characterized as having fallen into a “ring of fire”—a situation of high sovereign debt coupled with high governmental deficits. Unenviable membership in the ring of fire means that a country has “. . . the potential for public debt to exceed 90 percent of GDP within a few years' time, which would slow GDP [growth] by one percent or more.”8 As Exhibit I.6 indicates, these unfortunate countries in the ring of fire include the United States, the United Kingdom, Japan, France, and most of the PIIGS—Spain, Ireland, Italy, and Greece. By contrast, Norway, Sweden, Germany, Canada, and the Netherlands are in fairly good condition, with Finland, Denmark, and Australia holding the strongest positions on this measure.
Exhibit I.6 The Ring of Fire
Source: Bill Gross, “The Ring of Fire,” PIMCO Investment Outlook, February 2010, 4.
Thus, the issue of sovereign debt must be considered against this two-fold background. First, sovereign debt is a key part of the picture of financial irresponsibility on the part of many of the presumably richest and most powerful nations of the West. Resolving the consequences of this longstanding irresponsibility will take a major societal effort over a long period in each of these countries. Second, this malaise affects the countries that have led the world toward the West's cherished values of individual freedom and democracy, and their economic weakness has come to a crisis point just as the rise of countries such as the BRICs presents a serious challenge to the economic primacy of liberal democracies. Also, a resurgence of Islam may presage a serious global confrontation with the West's values of personal freedom and representative government.
These factors combine to make sovereign debt a critical piece of the economic and social challenge that the Western nations must face. Not too long ago, sovereign debt was a concern primarily, or even only, for developing and impoverished countries. A mere decade ago, one of the largest issues in sovereign debt was debt relief for the poorest countries. Today, it is the rich (or formerly rich) countries that face their own problems with sovereign debt, and there is no one to forgive these debtors. These themes are the issue that stimulated the development of this book.
ABOUT THE TEXT
All of the chapters in this volume represent the cutting edge of thinking about sovereign debt. The contributions stem from the authors' deep expertise in the subject matter. Almost all of the contributions are based on formal academic research conducted in the last two years. Accordingly, this book spreads before the reader the best thinking on sovereign debt by specialists drawn from top universities and key international financial institutions, including central banks, the International Monetary Fund, and the World Bank. All of the contributions in this volume have been especially written for the intended reader—a nonfinance specialist interested in understanding the vital importance of sovereign debt for the world's economic future. The book is divided into seven sections, and each is preceded by a brief essay describing the chapters in that section:
I. The Political Economy of Sovereign Debt
II. Making Sovereign Debt Work
III. Sovereign Defaults, Restructurings, and the Resumption of Borrowing
IV. Legal and Contractual Dimensions of Restructurings and Defaults
V. Historical Perspectives
VI. Sovereign Debt in Emerging Markets
VII. Sovereign Debt and Financial Crises
NOTES
1. For a riveting account of the rise and fall of Long-Term Capital Management, see Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management, New York: Random House, 2000.
2. This financial interconnectedness offers considerable benefits in normal times, but it also means that financial markets under stress can be subject to financial contagion—the propagation of financial distress in one firm, market, or economy to others. See Robert W. Kolb (ed.), Financial Contagion: The Viral Threat to the Wealth of Nations (Hoboken, NJ: John Wiley & Sons, 2011).
3. See Francis Fukuyama, “The End of History?” The National Interest, Summer 1989, and The End of History and the Last Man (New York: Free Press, 1992). Samuel P. Huntington advanced the clash of civilizations point of view: “The Clash of Civilizations,” Foreign Affairs (Summer 1993, 22–49), and The Clash of Civilizations and the Remaking of the World Order (New York: Simon & Schuster, 1996). See also Robert Kagan, The Return of History and the End of Dreams (New York: Knopf, 2008).
4. Robert Fogel, “$123,000,000,000,000,” Foreign Policy, January/February 2010. By contrast, other well-placed observers see a more modest rise in Chinese economic power: Robert D. Kaplan, “The Geography of Chinese Power,” Foreign Affairs (May/June 2010), 22–41.
5. For a gradualist perspective, see Fareed Zakaria, The Post-American World (New York: W.W. Norton, 2008). Zakaria sees the fall of the United States as resulting more from the “rise of the rest,” rather than from an actual fall. Niall Ferguson represents the view that sees sudden collapse as possible: “Complexity and Collapse,” Foreign Affairs, March/April 2010.
6. For the idea that the BRIC countries hold the key to world economic development, see Dominic Wilson and Roop Purushothaman, “Dreaming with BRICs: The Path to 2050,” Goldman Sachs Global Economics Paper No. 99, October 1, 2003.
7. Bank for International Settlements, 80th Annual Report, June 28, 2010, 23.
8. Bill Gross, “The Ring of Fire,” PIMCO Investment Outlook, February 2010.
REFERENCES
Bank for International Settlements. 2010. 80th Annual Report. June 28.
Credit Market Analysts, Ltd. 2010. “Global Sovereign Credit Risk Report.” Second Quarter.
Ferguson, Niall. 2010. “Complexity and Collapse.” Foreign Affairs. March/April.
Fogel, Robert. 2010. “$123,000,000,000,000.” Foreign Policy. January/February.
Fukuyama, Francis. 1989. “The End of History?” The National Interest. Summer.
———. 1992. The End of History and the Last Man. New York: Free Press.
Gross, Bill. 2010. “The Ring of Fire.” PIMCO Investment Outlook. February.
Huntington, Samuel P. 1993. “The Clash of Civilizations.” Foreign Affairs. Summer, 22–49.
———. 1996. The Clash of Civilizations and the Remaking of the World Order. New York: Simon and Schuster.
Kagan, Robert. 2008. The Return of History and the End of Dreams. New York: Knopf.
Kaplan, Robert D. 2010. “The Geography of Chinese Power.” Foreign Affairs. May/June, 22–41.
Lowenstein, Roger. 2000. When Genius Failed: The Rise and Fall of Long-Term Capital Management. New York: Random House.
Wilson, Dominic, and Roop Purushothaman. 2003. “Dreaming with BRICs: The Path to 2050.” Goldman Sachs Global Economics Paper 99. October 1.
Zakaria, Fareed. 2008. The Post-American World. New York: W.W. Norton.
ABOUT THE EDITOR
Robert W. Kolb received two PhDs from the University of North Carolina at Chapel Hill (philosophy, 1974; finance, 1978), and has been a finance professor at the University of Florida, Emory University, the University of Miami, and the University of Colorado at Boulder. He was assistant dean of Business and Society, and director of the Center for Business and Society at the University of Colorado at Boulder. Kolb was also department chair at the University of Miami. He is currently at Loyola University Chicago, where he holds the Frank W. Considine Chair in Applied Ethics.
Kolb has published more than 50 academic research articles and more than 20 books, most focusing on financial derivatives and their applications to risk management. In 1990, he founded Kolb Publishing Company to publish finance and economics university texts, built the company's list over the ensuing years, and sold the firm to Blackwell Publishers of Oxford, England in 1995. His recent writings include Financial Derivatives 3e; Understanding Futures Markets 6e; Futures, Options, and Swaps 5e; and Financial Derivatives, all co-authored with James A. Overdahl. Kolb also edited the monographs The Ethics of Executive Compensation, The Ethics of Genetic Commerce, Corporate Retirement Security: Social and Ethical Issues, and (with Don Schwartz) Corporate Boards: Managers of Risk, Sources of Risk. In addition, he was lead editor of the Encyclopedia of Business Society and Ethics, a five-volume work.
Two of Kolb's most recent books are Lessons From the Financial Crisis: Causes, Consequences, and Our Economic Future, an edited volume published by John Wiley & Sons, and The Financial Crisis of Our Time, published in 2011. In addition to the current volume, he also recently completed Financial Contagion: The Viral Threat to the Wealth of Nations.
Acknowledgments
No one creates a book alone. In the first instance, this book was created by the many contributors who extended their wisdom and knowledge to the project. Also, Ronald MacDonald at Loyola University in Chicago served as an extremely capable editorial assistant, while Pooja Shah, also at Loyola, provided immediate and expert research assistance. At John Wiley & Sons, I have benefited from working closely with my editor Evan Burton, who encouraged me to undertake this project. Also at Wiley, Emilie Herman and Melissa Lopez have both managed the production of this volume with their typically high level of expertise.
To these approximately 100 people I extend my sincere gratitude for making this book possible.
ROBERT W. KOLBChicagoJanuary 2011
PART I
The Political Economy of Sovereign Debt
The chapters that comprise this section focus on the most sweeping issues of sovereign debt—the role that this debt plays in the essential economy of a nation and how sovereign debt interacts with societal dimensions beyond the merely financial. As the introduction has tried to make clear, sovereign debt has a worldwide economic importance that it has never had before, and this is due to the economic difficulties and societal challenges faced by so many of the heretofore most successful nations of the world. Accordingly, this section focuses on the overarching theory of sovereign debt, the levels of debt that nations can sustain, the problem of default, and the sanctions that lenders use to enforce their claims against governments that are reluctant to pay as promised.
In addition, these articles examine the effect of sovereign debt and defaults on the overall economic productivity of a nation. Further, some of the most egregious episodes in the history of sovereign debt arise from countries with a “resource curse”—a valuable resource that promises a horn of plenty but that has historically been associated with slow economic growth and a reluctance or inability to pay on sovereign debt.
A sovereign’s ability to conduct war depends on money. As Cicero noted more than 2,000 years ago, “Endless money forms the sinews of war.” Had Cicero lived in our time, he might have added: “And many nations attempt to fashion these sinews from debt,” as many nations have attempted to construct these sinews by issuing sovereign debt, and success or failure in sovereign debt management has meant victory or defeat in many wars. Thus, sovereign debt connects with matters of great societal import—in some instances, sovereign debt determines the very survival of the state and society.
Chapter 1
Sovereign Debt
Theory, Defaults, and Sanctions
Robert W. Kolb
Professor of Finance and Considine Chair of Applied Ethics, Loyola University Chicago
For more than 2,000 years, sovereign governments have borrowed and frequently defaulted. In many instances, the sovereign borrower possessed overweening power compared to the unlucky lender, leaving the hapless creditor little or no means of collecting the debt. In more recent historical times, sovereign borrowers have been smaller, weaker, and poorer nations, and their lenders have been financial institutions lodged in the world’s most powerful states. On some occasions, those lenders were able to enlist the military power of their own countries to enforce their private claims against the sovereign borrowers to make them pay. (These governments were presumably willing to use their military power on behalf of their financial institutions because doing so met the perceived interests of the governments themselves, or at least the interests of those individuals who held office.)
These episodes of gunboat diplomacy or supersanctions were quite effective and far from rare in the period of 1870–1914, a time of widespread adherence to the gold standard in exchange rates. A clear instance of gunboat diplomacy occurred at the turn of the twentieth century. A revolution in Venezuela that began in 1898 destroyed considerable property, and the government stopped paying its foreign creditors. In response, Great Britain, Germany, and Italy blockaded Venezuelan ports and shelled coastal fortifications, compelling Venezuelan compliance. The experience of Egypt provides an example of a nongunboat supersanction. Under the leadership of Isma’il Pasha from 1863 to 1879, Egypt borrowed and spent, notably to finance a war with Ethiopia. Unable or unwilling to pay these debts as promised, Pasha sold the Suez Canal to Great Britain in 1875. With Egypt’s debts still not satisfied, Great Britain pressured the Ottoman sultan to depose Isma’il and replace him with his son Tewfik Pasha in 1879. In response to a period of missing debt payments and internal unrest, Great Britain took effective control of Egypt’s finances in 1882 and directed Egypt’s financial resources to the repayment of its foreign debts.1
Today, attempts to secure repayment by gunboat diplomacy or seizing another sovereign state’s finances are considered a bit outré, a circumstance that leads to the two central questions of the theory of sovereign debt: If the creditor cannot force the sovereign borrower to repay, why would the sovereign ever do so? Correlatively, without an ability to force repayment, why would any potential creditor ever lend to a sovereign borrower? The theory of sovereign debt addresses these two puzzles.
Before turning to a direct consideration of these issues, three preliminary points deserve mention. First, sovereign borrowers typically really do hold a different position from mere individuals or firms that borrow. While ordinary borrowers can be forced to repay through legal sanctions, sovereign borrowers today completely escape supersanctions and largely evade effective legal sanctions that might force repayment. Second, even in the post-supersanction period, and even with the inability to enforce collection with legal sanctions, sovereign lending remains quite robust. Despite a large number of defaults, sovereign debt is mostly repaid as promised. Third, the theory of sovereign debt attempts to explain the occurrence of lending and repayment in strictly economic terms. That is, the explanations that economists offer turn merely on the self-interest of the lender in extending credit and the borrower in making repayments. Economists never attempt to explain lending or borrowing behavior by reference to any moral obligation of fulfilling the promise to repay that borrowers make when they secure loans.
REPUTATIONAL EXPLANATIONS
One of the key rationales offered to account for the existence of sovereign lending turns on reputation. The argument asserts that sovereign governments want to maintain a reputation as a good credit risk to assure future access to international funds, so they repay the debts they owe now. As a result, lenders feel sufficient confidence to extend funds. There is no doubt considerable, yet somewhat limited, truth in this view. But the desire for continuing access to funds works hand in hand with the sanctions that do still prevail in the arena of sovereign debt. While these sanctions fall considerably short of the supersanction of invasion, they can have considerable force. For example, if lending institutions can punish a small developing nation that defaults by interfering with its international trade or by seizing that nation’s assets held abroad, these sanctions can provide additional reasons for debtor countries to repay. Thus, the threat of sanctions also stimulates countries to repay. So reputational concerns interact with responses to limited sanctions to encourage sovereign debtors to pay.
From the point of view of theory, however, there is a question of whether reputational considerations alone are sufficient to make sovereigns pay. In the parlance of the theory of sovereign debt, if the value of a good reputation is sufficient to make lenders pay as promised and sufficient to encourage lenders to extend funds, then reputation is said to support sovereign lending.
To simplify matters, assume that there is a single lender (or that all lenders act monolithically), and if a country defaults, it is excluded from borrowing forever. Several studies advance reputation as grounds for sovereign lending (Eaton and Gersovitz 1981; Eaton, Gersovitz, and Stiglitz 1986). The first thing to notice about such theories is that they pertain to an environment in which borrowing continues infinitely, or at least indefinitely from year to year. If the borrower knows that the current year is a terminal year, after which there will be no lending, the borrower would refuse to repay for the simple reason that there is no fear of exclusion from future borrowing. But lenders, also knowing that the current year is the terminal year, would also recognize that they will not be repaid, so they will not lend for that final period. In the second-to-last year, the borrower would not repay because it would know it could not borrow in the terminal year for the reasons just given. But the lender is assumed to have the same information, so it would not lend in that penultimate year, because it would realize it would not be repaid. This argument of backward induction can be repeated for all years from the horizon back to the present, thereby showing that explanations of sovereign debt based on reputation alone can work only in an environment of perpetual lending and borrowing. Or at the very least, there must be some continuing probability of borrowing and repaying into the indefinite future.
If withholding future lending is the only sanction that lenders can impose, other potential breakdowns in lending arise. For simplicity, consider an environment of a single borrower and a single lender. Assume that the maximum debt capacity of the borrower is 100 units and the lender advances one unit in each loan up to this limit. When the debt capacity of the borrower reaches the limit of 100 units, the lender refuses to make new loans. However, at this point, the reputation for repayment has no prospect of securing future loans, because the borrower has borrowed so much it knows it can never borrow any more. In this situation, the threat of exclusion from future loans has no force, and a reputation for repayment has no value in securing future loans. Having reached this limit of borrowing with no future prospects for loans, the borrower would refuse to repay the loan. However, the lender will also recognize this prospect and will not allow that situation to arise.
But now consider the situation in which the lender has advanced 99 units of credit. The borrower knows that it cannot secure the additional loan of one unit of borrowing for the reasons just given. So the borrower will not repay the loan at the 99 units of borrowing. The lender, too, recognizes this rationale on the part of the borrower, so it will not be willing to fall into this position of extending credit up to 99 units either. The same process of backward induction that applied for each period from the terminal period back to the present also applies from some hypothetical upper loan limit back to an initial loan, with the result that the lender can never extend even the first loan.
These two thought experiments—when borrowers and lenders both know they have reached the last period for a loan or when they know that they have reached the upper bound of lending—show the limits to reputation alone as a rationale for explaining sovereign borrowing. In both cases, the certainty on the part of both lender and borrower makes the venture fail. Thus, it is uncertainty about the future that makes reputation valuable in sustaining lending. A borrower’s reputation for paying as promised possesses value because of the prospect of securing a loan or expanding borrowing in the future.
BEYOND REPUTATIONAL EXPLANATIONS FOR SOVEREIGN DEBT
There are further limits to the reputational understanding of sovereign lending. Consider a country that has fluctuating production due to variable weather or other factors that affect harvests. Such a country might need to borrow in lean years to finance consumption, while repaying outstanding loans when harvests are bountiful or at least normal. Given these circumstances, this country might engage in sovereign borrowing followed by repayment with many repetitions in this cycle. For convenience, assume that the borrower country has reached its credit limit. At first glance, it may seem that the debtor nation has a choice of repaying with the prospect of future borrowings or defaulting and bearing the risk of future macroeconomic fluctuations on its own account.
However, a famous paper (Bulow and Rogoff 1989) shows that this is a false choice. Consider a country that has been borrowing in hard times and repaying when times get better but that has now borrowed up to the maximum any lender is willing to advance. In this situation, the country can also choose to refuse repayment and use the funds it owes to save against future macroeconomic shocks, earning interest until the shock occurs and the funds are needed. Thus, the country will be better off to default once it secures its maximum level of borrowing.2
Bulow and Rogoff (1989) consider an alternative to default and saving. The defaulting country might purchase insurance that pays when the country experiences future adverse macroeconomic events. Such an insurance contract would pay in those years in which production fell short. Therefore, Bulow and Rogoff contend, the country will also be better off if it defaults and purchases the macroeconomic insurance (or defaults and saves). As Bulow and Rogoff put the point, “Small countries will not meet loan obligations to maintain a reputation for repaying because, under fairly general conditions, it is impossible for them to have such a reputation” (p. 49). The purpose of Bulow and Rogoff’s argument is not to assert that reputation plays no role in understanding international lending to sovereigns, but to prove that reputation by itself is not adequate to explain the world of sovereign debt that we actually observe, especially if both the prospective borrower and the prospective lender have perfect information about the incentives of the other party. As a consequence, lending “must be supported by the direct sanctions available to creditors, and cannot be supported by a country’s ‘reputation for repayment’ ” (p. 43).
Other limitations with simple reputational explanations are also evident under real-world considerations. For example, early reputational explanations assumed that lenders acted monolithically, that if a sovereign defaulted against one lender, no other lender would advance funds, and that one default meant permanent exclusion from international borrowing. Both assumptions are empirically incorrect. Sovereign debtors are often successful in gaining additional funds from not only the same lender against whom they defaulted but also new loans from other lenders. Further, sovereign borrowers are often successful in playing one lender off against others. As we will see, history offers considerable evidence of notorious defaulters quickly gaining renewed access to international credit markets.
Given that reputation alone cannot support or rationalize the occurrence of sovereign debt, other adverse consequences or lender-imposed sanctions must play some role. Many models of sovereign default consider the effect that a default on one lender may have on the willingness of other potential lenders to advance funds. However, the consequences of default may be quite a bit broader. If a nation defaults on one obligation, this can adversely affect a variety of other trust relationships that the sovereign may also value. As the leading exponents of this theory have maintained, default in one arena can lead to adverse “reputational spillovers” that affect trust relationships much more broadly. Thus, the fear of collateral damage from these spillovers can make it rational for the sovereign to honor its promises to pay when it might choose to default based on very narrow considerations of that borrowing relationship alone (Cole and Kehoe 1997). For example, if a sovereign defaults to a foreign bank, other suppliers for that government may require payment in advance before shipping goods or providing services. Similarly, a default by a government on an international loan may signal to domestic constituencies that the government is not to be trusted. So the default on a bank loan may provide a signal to labor groups, voters, and citizens generally that their government is not to be trusted. If a sovereign default impairs other important trust relationships that the sovereign values, this raises the total cost of the default. Thus, even though it might appear rational on narrow economic terms for the sovereign to default, the total cost of default might be high enough to encourage the sovereign to avoid default and to pay as promised.
Default by a sovereign borrower is almost always a choice, and because the default is by a government, such a choice necessarily has a political element. Recent research finds that states with certain political circumstances are more likely to default than others. There is a long-standing view that states with a weaker central government afford better protection for property rights and experience higher rates of economic growth (De Long and Shleifer 1993). More recent research suggests that similar factors may influence the probability of sovereign defaults. In brief, weaker central governmental authority coincides with a lower probability of sovereign default (Kohlscheen 2010; Saiegh 2009; Stasavage 2007). Thus, countries with coalition governments tend to default less than those dominated by a single strong party (Saiegh 2009). From a historical perspective, city-states with a strong merchant class default less often than do large territorial states; similarly, states with stronger constitutional restraints on the executive power have a lower probability of default that do those with a very powerful executive (Stasavage 2007). Further, faced with imminent default, states increase the riskiness of their economic policies in an effort to “gamble for redemption”—that is, to secure sufficient funds to avoid default (Malone (2011, forthcoming)).
While the interaction of political factors and the propensity to default on sovereign debt remains incompletely understood, the general landscape of this interaction appears to be related to familiar issues in the realm of public choice economics. In particular, the interests of various political factions play a large role in determining the ultimate choice that states make with respect to default (Hatchondo, Martinez, and Sapriza 2007; Hatchondo, Martinez, and Sapriza 2011).
CREDITOR SANCTIONS AND SOVEREIGN DEFAULTS
We have already briefly considered an era in which rather extreme sanctions were enforced to collect sovereign debts. Assuming that invasion and gunboat diplomacy are no longer viable, what sanctions are available to creditors to encourage sovereign borrowers to pay as promised? This section briefly considers three famous episodes of sovereign default interacting with creditor sanctions across a span of more than 400 years. Together, they illustrate much of the broad range of the effectiveness and failure of creditor sanctions.
Defaults of the Spanish Empire in the Sixteenth Century
Historically, sanctions have sometimes been quite effective in securing repayment, even when the debtor appears to have all of the power in the relationship. In the late sixteenth century, the Spanish Empire under King Philip II from the house of Habsburg (reigned 1556–1598) held sway over much of Europe. Fueled by its silver revenues from the New World, Spain led European forces to victory at Lepanto in 1571 to turn back the Ottoman ascendancy in the Mediterranean, Spain’s armada embarked on a failed invasion of England in 1588, and its armies pursued a brutal war in the Netherlands over much of Philip’s reign. But the flood of silver from the mines of Latin America was not enough to sustain Spain’s expenditures. Sovereign debt would play a determining role in Spain’s attempt to solidify its control over the Netherlands.
During his 42-year reign, Philip borrowed from the banking magnates of Europe, and Spain defaulted four times: 1557, 1560, 1575, 1596. The most serious default and the one most illustrative of the import of sanctions was Philip’s default on Spain’s obligations to a coalition of bankers led by the Genoese in 1575. This default occurred at a critical moment in the war with the Netherlands: “The Habsburg default of 1575 led to a serious dislocation of international money markets at a delicate moment: prior to 1 September 1575 the Spanish position in the Netherlands had shown promise; after this date it proved impossible to satisfy the demand of the royal troops stationed in the Low Countries for pay and arrears. The Sack of Antwerp (‘the Spanish Fury’) which took place in the early days of November 1576 was a direct result” (Lovett 1980, p. 899).
While scholars generally agree that the default of 1575 resulted in a shortage of funds to meet Spain’s military payroll and thus hampered the conduct of war in the Low Countries, they disagree on just how the bankers’ sanctions brought Philip to heel. Philip paid his troops in coins, so it was absolutely necessary to obtain specie in the Netherlands. According to one leading explanation, this transfer of funds was under the management of the banking houses of Europe through letters of credit, as well as via physical shipments of bullion. When Spain defaulted, the bankers strangled the transfer of funds from Spain to the Netherlands, leaving the troops without pay: “The Genoese imposed an embargo on specie transfer on Philip. The Crown was unable to get appreciable funds to its troops in Flanders, with the result that in November 1576 troops mutinied over arrears and sacked Antwerp, a strategic entrepôt in Spanish possession” (Conklin 1998, p. 510).
Emphasizing the importance of the bankruptcy of 1575 and the bankers’ consequent sanctions for the conduct of war in the Netherlands, Drelichman and Voth (2008) offer an alternative account of the sanctions that brought Philip to heel. In their view, the refusal of all bankers to lend following the default was the effective sanction. Drelichman and Voth maintained that transfers of specie actually continued at a healthy pace after the default: “There is no evidence that the Genoese ‘transfer embargo’ had any effect on the availability of funds in the Flanders theatre of war” (p. 22). Instead, Drelichman and Voth assert that the bankers of Europe successfully maintained their antilending cartel until Philip knuckled under to their financial demands, and it was this cessation of lending that kept the Spanish troops in Flanders unpaid.
Whether the interruption in pay to the Spanish troops stemmed from an embargo on transferring funds or from a refusal to lend, the sanctions imposed by Spain’s creditors were the leading factors in forcing Philip to settle and resume payments on Spain’s debt, which he did in 1577. As a result, lending resumed, paving the way for Philip’s last default in 1596. While it might appear on first inspection that a coalition of bankers might have little power relative to the greatest empire in an age of empires, the fact turns out to be quite otherwise. Clearly, the bankers managed to make Spain comply with their demands, whether by blocking the transfer of coin to the Low Countries or by refusing to sustain Spain’s need for additional financing.
Peru and Its Guano
In more recent times, the typical sovereign borrower has been a developing country with an economy based on the export of raw materials that acquires bank loans from international banks. As an exporter, the borrower country clearly gains from international trade and participates in the international financial system. Against this background, the role of sanctions in sovereign lending is to raise the cost of default sufficiently high to make repaying the foreign obligations in the self-interest of the sovereign debtor.
One of the most instructive instances of the value of sanctions comes from a situation in which sanctions were never actually enforced—a tale of a dog that did not bark—and it involves nineteenth-century Peru.3 In the early 1820s, Peru fought for its independence against Spain and floated bond issues in London to finance its revolution. But Peru defaulted in 1826 and remained in default until 1849, with its bonds trading as low as 20 percent of par. As the low price of Peru’s bonds during this period indicates, Peru’s creditors had few effective sanctions to make Peru pay, and the bond market saw little prospect of Peru’s actually paying on the bonds. However, Peru reached a settlement with its debtors in 1849 and then enjoyed more than 20 years of easy access to world capital markets at attractive borrowing rates. During this period, it floated many bond issues for purposes ranging from debt management to financing railway construction and other wars.
What rescued Peru from the mire of default? As with most sovereign defaults, Peru’s problem from 1826 to 1849 was not its ability to pay, but its willingness. Peru’s change from unwilling defaulter to active participant in world capital markets began with the travels of Alexander von Humboldt, a famous German scientist who traveled to Peru in 1802 and wrote of the rich deposits of guano on Peru’s Chincha Islands, which lie 20 kilometers off Peru’s coast. Production had already started in the early 1840s, but in 1849, the government of Peru attempted to rationalize the production and sale of this potentially valuable resource.
Europe, with its high demand for fertilizer, was the main market for the Peruvian guano, but Peru’s principal unsatisfied creditors on its defaulted sovereign debt were also based in Europe, most notably in Great Britain. As a consequence, the Peruvian government feared that its guano exports would be seized in repayment of the outstanding debts. These fears were of real weight. The holders of the defaulted bonds had already noted in 1847 that the guano was by itself sufficient “to provide for the liquidation of its [Peru’s] foreign debt, and that consequently the [British] government is bound by every principle of public faith and national honour to proceed to that stipulation without further delay.” For its part, the Peruvian finance minister noted that “until the foreign debt is settled, the remission of guano abroad … could bring major complications that we must avoid” (Quoted in Vizcarra 2009, p. 371).
While these fears of seizure may have been exaggerated, Peru certainly faced the problem of restricted access to capital markets. With its bonds sitting in default, further financing from abroad was unlikely. Further, Peru very much needed new financing to make the extraction and sale of its guano possible. Loading a ship with guano could take a month, and the voyage to Europe was lengthy so the transportation cost was high. Further, “procurement of vessels and coordination of sales, foreign warehousing, and marketing were also costly and demanded a certain degree of expertise that the Peruvian government lacked” (Vizcarra 2009, p. 367). Peru solved this dilemma by contracting with a highly reputable British merchant bank, Anthony Gibbs and Sons, to manage this process and to collect its sales receipts in Europe. Peru authorized the Gibbs bank not only to collect all the guano revenues but also to withhold 50 percent of them to service Peru’s foreign debt. The Gibbs company had considerable reputational capital of great value, so it was unlikely to cooperate with Peru to defraud new lenders.
With these new arrangements in place, Peru now had the means to capitalize on its guano deposits. Key to this was an arrangement that gave Peru’s creditors confidence that Peru would pay. Because the proceeds from selling guano were realized outside the boundaries of Peru and passed through the hands of Gibbs and Sons, who had the confidence of Peru’s foreign creditors, Peru had solved the problem of being able to make a “credible commitment” to pay its debts.
As an alternative to allowing Gibbs and Sons to control its guano-based cash flows, Peru might have tried to secure new financing to allow it to exploit its guano and to receive payment in Peru when the guano was loaded. However, given its record of defaults, new borrowing was unlikely. What lender would want to lend merely on Peru’s promise of future payments? But having the revenues from guano realized outside the country by a reputable third party gave lenders the confidence they needed to advance new funds.
The Russian Federation in 1993
Shortly after the breakup of the Soviet Union, the Swiss firm known as Noga, led by Nessim Gaon, signed a deal with the first post-Soviet government in 1991. Noga exported goods including medicine and pesticides to Russia in exchange for oil, and the Russian Federation explicitly waived sovereign immunity. The deal quickly fell apart, after $1.5 billion in trade had already occurred, and Russia refused to send any more oil. Noga, claiming a loss of approximately $100 million, sued in 1993 and secured a court ruling that froze Russian government bank accounts in Luxembourg and Switzerland. Noga secured more legal victories, including an order by a French court to seize the bank accounts of many Russian state enterprises holding funds abroad.
Beyond freezing bank accounts, Noga also pursued other avenues of harassing the Russian government: “In 2000, the Royal Museum of Art and History in Belgium was forced to abandon a show of Russian Art Treasures when it could not gain legal guarantees against the seizure of the art… . In 2000, a French presidential decree was made to prevent the seizure of president Putin’s personal aircraft at Orly Airport in Paris… . [In 2000] the Russian tall ship Sedov … was impounded in the port of Brest in France… . Threats of seizure in 2000, led Russia to halt shipments of nuclear warheads to the USA for reprocessing until President Clinton signed an executive order guaranteeing immunity of the uranium from seizure” (Wright 2002, pp. 36–37).
Noga pursued its claims with remarkable persistence over the years. In 2001, Noga attempted to seize two Russian fighter jets at the Bourget air show, but the jets escaped with the warning and collusion of the show’s organizers (Wright 2002, p. 37). In subsequent years, Russian planes were unaccustomedly missing from other European air shows, apparently due to fear of Noga’s attempted seizures (Nadmitov, (n.d.), p. 56). Over the years, Noga continued its pursuit of restitution, winning a victory in a French court as recently as 2008 (Aris 2008). But Noga’s quest apparently ended in 2009, when Noga lost a decision in the U.S. Court of Appeals for the Second Circuit.4
