The world has been in some sort of crisis or other since 2008. The reason? Debt. Initially it became clear that too much money had been lent to subprime borrowers in the mortgage market.
Governments in many cases had to stand in to ensure bank solvency.
The latest phase of the crisis, however, is not a matter of banks lending to subprime borrowers who can’t pay them back, it is banks lending to governments that don’t want to pay them back.
The analogy can seem confusing. While on one hand it is easy to understand how an individual can become insolvent, how can a government, with billions in state assets and the capacity to raise taxes from its population, go bankrupt, or more precisely default on its debts?
The answer lies in the rather vague and remarkable drafting of sovereign bonds.
Under the current system sovereign bonds in the main do not come with any security other than the good name of the government issuing them. Some states are always going to be able to make payments on their bonds as they control the printing presses. The UK and the US are therefore guaranteed to make good on their debts, albeit at the potential cost of inflation.
Governments in the eurozone, however, do not have the capacity to print euros. That privilege rests with the European Central Bank. This arrangement has meant that, rather than being able to print their way out of trouble, countries such as Greece, Italy, Ireland, Portugal and Spain must look to other ways to pay off their euro-denominated debts.
The causes of sovereign debt default can only be a function of two variables – governments have either spent too much or earned too little. With left-leaning European countries it would appear the ambition of handing out benefits, employing too many people and underwriting social programmes has gone too far. Nobody in Europe would argue against such programmes, but they have to be affordable. If they are not increasing borrowing through the bond market and eventual default are inevitable.
The solution has to be long-term fiscal responsibility. The only credible body that is able to enforce this is, ironically, the bond market. In modern democratic states politicians are able to spend taxpayers’ money to benefit their client and principal constituency groups.
Typically the bill for this spending is picked up by future taxpayers. Politicians will always be committed to benefitting their client groups, whether tax contributors or benefit recipients.
After all, that is how they are elected.
The bond market’s influence and capacity to impose fiscal responsibility has rarely been more obvious. The UK Government has taken care to point to its fiscally responsible stance and its triple-A credit rating. Also, we have seen other countries essentially running fiscal policy with one eye on the cost of credit in the international bond market.
The spectre of inevitable Greek default should therefore give buyers of bonds and drafters of sovereign debt instruments pause for thought. If they had a security guarantee, as demanded by Finland and others in the EU, Greece may have thought more carefully before allowing public sector workers to retire in their 40s.
In the final analysis it is likely that Greece will default and bondholders will be unable to recover their money from a solvent creditor as a result of their lack of insistence on security.
Asset-backed state collateral is the best chance of long-term fiscal responsibility to provide discipline for governments. The arguments against are simply excuses for states to write cheques their taxpayers don’t necessarily have to cash.