Any economic slowdown increases debt burdens, whether forhouseholds or for states. Today, both are looking for ways to reduce the weightof debt – and some would prefer to escape it.
Deeply frustrated and angry people – especially in southernEurope – frequently hold up Argentina’s defiance of the international community in 2001 as amodel. Argentina then used a mixture of coercionand negotiation to get out from under themountain of debt that it incurred in the 1990’s, effectively expropriating foreign creditors, who were viewed asdangerous and malign.
In the 1990’s, Argentina tied its hands with adollar-pegged currency in order to enhance its credibility as a borrower. Thestrategy worked too well: the large credit inflows that it attracted triggeredan inflationary boom that reduced the country’s competitiveness. By 2001, acombination of devaluation (exit from the currency straitjacket)and partial default was inevitable. Default was followed by nominally voluntaryrestructurings in which creditors were invited to take some losses.
Up to now, the Argentine model has seemed successful,yielding substantial economic growth for the country since 2001. That is whathas made the model so appealing to debt-burdenedsouthern Europeans.
But a recent New York court ruling against Argentina in a case broughtby a holdout hedge-fund creditor hasdramatically raised the stakes of sovereign default and bankruptcy. When holdouts are rewarded by court decisions, and therights of recalcitrant creditors are recognizedin other jurisdictions, efforts at “voluntary” restructuring becomeunsustainable. More and more parties will resist writing down some debt infavor of trying to seize whatever assets they can.
For Argentina, the writing is now on the wall. One of thecreditors favored in the New York case, Elliott Capital, had already successfullyrequested the seizure in Ghana of the ArgentineNavy’s three-mast sailingship ARA Libertad. If the fallout of the NewYork decision is an extensive Argentine default on other obligations, foreigntrade will become practically impossible, many goods will become scarce, anddomestic inflation will increase further. In short, the Argentine model of debtreduction in the 2000’s has collapsed as completely as its borrowing model inthe 1990’s did.
Two fundamental facts have created an apparently insoluble dilemma for the global economy, and haveturned countries like Argentina and Greece into victims of an impossible logic.First, debt continually grows; second, there is noreally satisfactory way of getting rid of it.
The financial sector’s explosive growth over the past twodecades has fueled the accumulation of exceptionally large volumes of debt. Inthe absence of some positive shock – such as an acceleration of GDP growth – servicing that debt becomes impossible for at leastsome borrowers.
Real debt defaults are historically rare. For both borrowersand creditors, the risks and costs are enormous. The borrower is cut off frominternational markets, and essential imports can no longer be purchased, whilelarge-scale defaults threaten to plungecreditors into insolvency.
The consequence is a complicated game – currently exemplified by the sagaof Greek voluntary restructuring – in which both sides stareinto the abyss and then turnaway from the out-and-out conflict thatwould send them plummeting into it.
Latin America experienced this dilemma in the 1980’s, whenits debt arithmetic had become unsustainable. Atthe outset of that crisis, major US financialinstitutions’ capital exposure to Latin America was near 200%, making candid recognition of debt unsustainability the surestroute to wiping out the global financial system.
Most of the big Latin American debtors took extraordinarypains to avoid an explicit default. The only sustained exception was Peru,which defaulted in 1985 and became an international pariah.Of the largest borrowers, only Brazil, in 1987, formally defaulted – and onlybriefly. As President José Sarney, backing down,admitted, “The fact is that we cannot destroy the international system. We can scratch it, but it can destroy us.”
Instead, banks in the 1980’s offered new money in anattempt to extricate themselves from the crisis.Managing modern debt crises always involves the extraordinary logic of throwing good money after bad in the hope of masking the underlying unsustainability. The samelogic has been applied in the euro crisis, with official money taking the placeof private-sector exposure.
The emergence of inextinguishabledebt replicates other troubling aspects of contemporary life. Governments,businesses, and individuals all face the build-upof other sorts of liabilities in the form of accumulations of information thatcannot be deleted. E-mail, Facebook, and Twitter accounts all produce apermanent record that perpetually accompaniesusers, even when their circumstances change. The legacy of the past continuallyresurfaces to constrain action in the present.
Just as countries might want towipe out their debt and start anew,individuals might like to erase their electronicpast in a dramatic act of liberation. But that would destroy the usefultogether with the embarrassing or irrelevant. If a clean start is impossible,the best that can be done is to try to bury the old information with such aninflationary flood of new data that it simply dwindlesinto insignificance.
The analogue in the world ofdebt negotiation is that a new start that allows borrowing to begin all overagain is also impossible. A cleanup isimpossible. That leaves only one solution: pile on newclaims to such an extent that old debts appear paltry.Those who cannot forget the past are condemnedto inflate it.