Global Debt Wars

Transcript

Archive Recording: We’re going to begin with the economic consequences of this escalating outbreak.

Archive Recording: It’s put Wall Street into that steep slide and it’s threatening main streets across the country now, from big companies to small mom-and-pop shops.

Archive Recording: Schools, work, even iconic institutions like Broadway and Disney world are shut down.

Archive Recording: To begin with breaking news at this hour, the US is now headed toward a wartime footing in the fight against the pandemic.

Archive Recording: Its record size. It was with record speed that Congress passed this massive legislation.

Archive Recording: European leaders have sealed a deal on an unprecedented €750 billion ($868 billion) coronavirus recovery fund.

Archive Recording: President Biden’s first federal budget proposal looks to transform the economy from transportation to education, all the while confronting climate change.

Archive Recording, Senator Rand Paul: Isn’t there some kind of ramification to so much borrowed money?

Barry Eichengreen: Hi.

BE: How are you two?

BE: All’s well here.

BE: This one is audio only, is that correct?

BE: My origin story begins probably with the Greek and Roman empires. So Aristotle wrote about the anesis of Syracuse forcing loans on the citizenry. Then you see later instances where various Greek cities, in order to fight enemies, borrow from individual investors, borrow from religious foundations which are managing the states, and therefore have a lot of assets. So, sometime around 400 BC.

BE: So, if you go to the Fitzwilliam Museum in Cambridge, England, you can see a slab that records the loans that were extended by the Temple of the Delians on the island of Delos around this time. And they record how much the temple – the religious foundation – lent to, I think, 13 Greek city-states – borrowers – and how those loans lapsed into default, how the interest and principal were not promptly repaid. If you’re victorious in your military campaign, you’re better able to repay than if you’re not. So this is also a reminder that lending to states is fraught, that there’s no guarantee that you’ll be repaid.

BE: So the first part of the book is self-consciously Eurocentric, because the development of modern markets and sovereign debt is a European phenomenon. Europe in the early modern period was divided into literally hundreds of city-states and territorial states with porous borders and hostile sovereigns just on the other side. So a sovereign who cannot defend the borders of his territory is not going to remain on the throne for long, both because he’s apt to be overthrown by hostile invaders who want to seize the crown jewels and the royal treasury, but also because the residents, the citizenry, will not be protected from those hostile invaders and will not support the regime.

So the ability to secure the borders of the princely kingdom of the state is really integral to the legitimacy of the realm. And the way early sovereigns did that typically was by hiring mercenaries. And you’ve got to pay them, or they’re not going to work for you. So you’ve got to mobilize a lot of financial resources in short order. It’s hard to do that by taxing commerce or imports or whatever. You raise a lot of financial resources in short order by borrowing.

BE: So that experience is a reminder that states and sovereigns borrow for good reasons, but also for bad reasons. The Egyptian case is famous, or infamous, in the historical literature in that the head of state, the Khedive, borrowed to hire ballet dancers to entertain the court. And when you borrow for those kinds of unproductive purposes, the likelihood that you’ll be able to repay promptly is less. And in that instance, default on those Egyptian debts led to British bombardment of Alexandria and, eventually, political seizure of Egypt. So, clearly the record of sovereign borrowing and lending is mixed.

We have quite a discussion in the book about gunboat diplomacy and whether debt problems provide a pretext for gunboat diplomacy desired on other grounds. Were the British really interested in control of the Suez Canal? And the Egyptian state’s debt problems provided a pretext to seize control. That would tend to be my view, although, and similarly of the United States and its interventions on behalf of creditors, on behalf of bondholders in Cuba, in Central America, in Venezuela. I think it tended to be geopolitical considerations that led to this kind of intervention. That could provide a pretext. And the fact that borrowing governments open themselves up to this danger by over-borrowing and not being able to repay was not always something that they took heed of.

Archive Recording, President Franklin D. Roosevelt: I shall ask Congress for the one remaining instrument to meet the crisis: broad executive power to wage a war against the emergency, as great as the power…

BE: So another aspect of the legitimacy of the modern state is ability to protect citizens from risks that they can’t protect themselves from. We talk about the social-insurance state. So to protect individuals from unemployment that they experience in a recession through no fault of their own, the state develops unemployment insurance and welfare and so forth. It’s not a coincidence that we see these programs develop starting in the 1930s – a severe downturn that illustrates the need for them and that underscores the legitimacy of the state undertaking these functions. And it’s not a surprise that we see these developments after the franchise has been broadened, after who can vote has been expanded, as a result of ongoing trends, but heavily as a result of World War I, that you can’t send men off to fight in the trenches and not give them the vote when they come back. So there is popular pressure for the expansion of things like unemployment insurance and old-age pensions and the like shortly thereafter. So you see the early development of the social-insurance state in the 1920s, and especially in the hard economic times of the 1930s. And then you really see it after World War II.

BE: I think probably the most important aspect of the post-World War II financial system was that financial markets and institutions were very heavily regulated. Number one, interest rates were relatively low after WWII, courtesy of strict financial regulation, which, for example, capped the interest rates that banks could offer depositors on their bank accounts. And that pushed savers into buying things like government bonds, keeping the yield or the interest costs governments paid down. And importantly, fast economic growth. The French talk about the 30 glorious years after WWII, when the economy grew at unprecedented rates.

So it really was a combination of factors: low interest rates, high economic-growth rates, and fiscal discipline, if you will, that enabled countries to deal with that very heavy inheritance of debt bequeathed by WWII. That of course, points to the implicit question of, can they do it again?

Archive Recording, Jesús Silva-Herzog Flores: I told them a very old Mexican expression. We owe you money; I recognize it. But I don’t have any money to pay you back.

Archive Recording: As finance minister in 1982, Jesús Silva-Herzog Flores broke the news to the world that Mexico would hold repayment of its debt, triggering a continent-wide crisis.

Archive Recording: It was a crisis which taxed the nerves of the World Bank, the IMF, and the United States Federal Reserve.

BE: Developing countries and emerging markets run up against debt constraints – they run into the wall – more quickly than advanced economies, because they have less capacity to raise tax revenues and service their debts, because they often have to borrow in dollars rather than in their own currency. So their own central banks can’t help with the debt-management problem like advanced-country central banks have been doing for the last few years. So, when Mexico, having borrowed dollars in the 1970s… Recall, this was the period of petrodollar recycling when Saudi Arabia was earning lots of dollars courtesy of suddenly higher oil prices. The [Saudi] government turned around and deposited this money in banks in New York. And banks in New York looked for a place to put it to work, and they put it to work in Mexico, despite the existence of economic problems there.

When Mexico encounters those problems in 1982 and says, “Sorry, we can’t repay what we’ve borrowed,” the IMF, with encouragement from the US government, comes in, extends Mexico a bridge loan, but doesn’t put pressure on the banks to offer concessions to write down the value of those loans or agree to take 50 cents on the dollar on the grounds that half a loaf is better than none. And therefore, the crisis drags on. Mexico, if anything, becomes more heavily indebted, because now it owes money to the IMF in addition to still owing money to the banks.

So it took really until 1989 – seven-plus years later – for a US treasury secretary, Nicholas Brady, to come along and encourage the banks to write down their loans, put in place, with help from the World Bank and the IMF, a mechanism for those defaulted bank loans to be converted into bonds at 50 cents on the dollar. That works, and that bequeaths what we have today, which is an international bond market, where countries that want to borrow don’t borrow from Citibank in New York like they did in the 1970s, but they borrow instead on the bond market.

BE: Well, I think we saw in the global financial crisis in 2008-09, and again during the COVID emergency and lockdown, the value of public debt. So, our book is entitled
In Defense of Public Debt, and the argument is that a global financial crisis or a global pandemic is the equivalent of war in the sense that it more than justifies government doing whatever it takes to meet the immediate emergency – in 2008-09 to prevent the financial system from collapsing and to prevent an even more serious recession than we experienced at that time.

So I think the conversation was shifted by that observation, by that realization, and then by the premature turn back to austerity. People said, “Well, the financial crisis in 2009 was an emergency, but come 2010, it’s over. So we can go back to business as usual by raising taxes, cutting spending, and balancing budgets.” But if you do that too quickly, you plunge the economy back into recession.

Archive Recording: Overseas now to Greece, a country on the brink of collapse. Banks shuttered; ATMs running out of cash.

Archive Recording: Endless lines at ATMs, with withdrawals limited to just $67.

Archive Recording: The Greek government says it doesn’t necessarily want a bailout, but it may have no choice.

Archive Recording: We’re getting some incredible pictures from Greece today, where the protests have begun in earnest. In fact, we’re seeing flames and fires starting.

Archive Recording: Forty-year-old Alexis Tsipras is the new prime minister of Greece. Greeks delivered an historic win to the leftist Syriza party with a surprisingly large share of the vote. Analysts say it was a clear rejection of the previous government’s austerity policies.

Archive Recording: A new anti-austerity party is also gaining popularity in Spain, Europe’s fifth-largest economy. On January 31, as many as 150,000 people rallied in Madrid to show support for the Podemos party. That translates into “We can.”

BE: As you say, in a highly polarized democratic setting, there can be a temptation for one political faction to borrow in order to finance spending on its preferred programs before the next election when political control is turned over to another political faction with very different preferences. So we see in the history – certainly in the history of the United States, but more broadly – a correlation between the extent of political polarization on the one hand, and debt accumulation to finance current spending on the other. And again, I think this is something that we are seeing in the United States at the moment. The Democrats trying to get their infrastructure package and their social infrastructure package through the Congress, if necessary with additional borrowing before the midterm elections, when they may lose the capacity to do that.

Archive Recording, President Joe Biden: In the midst of this pandemic, there are millions of people out of work, unable to pay their rent or their mortgage. The bottom line is the job report shows we need to provide more immediate relief for working families and businesses now.

Archive Recording, Chancellor of the Exchequer Rishi Sunak: To all those at home right now, anxious about the days ahead, I say this: you will not face this alone.

Archive Recording: G20 finance ministers have agreed to suspend debt-service payments for 77 low-income countries. The World Bank estimates that highly indebted countries owe nearly $14 billion in 2020.

BE: I think that the fact that there was not an inflationary explosion after the fiscal response to the global financial crisis in 2008-09 was one factor that informed the decisions of governments starting in 2020. Back then, people warned, “You can’t respond to this crisis in 2008-09 with all this deficit spending because you will only foment inflation.” And it didn’t happen. So I think that’s why governments felt freer to turn to deficit spending bigtime starting in 2020.

The other point is that there were worries in 2008-09 about what economists call moral hazard – that if government spends more to bail out the banks, the banks will only engage in more risky behavior going forward. And by solving this financial crisis, you only set the stage for future financial crises. COVID-19 was not something that we brought upon ourselves. So the danger of moral hazard – that by addressing this emergency, we will only set the stage for another novel coronavirus – didn’t apply. I think the differences between that crisis in 2008-09 and this one were also important for informing what governments have done for the last couple of years.

BE: There is a debate about whether attitudes toward the role of government – that’s fundamentally what we’re talking about – and the role of debt finance in enabling that more expansive role for government. There’s a debate about whether this is a sea change, and we’re moving from the neoliberal order that started with Ronald Reagan in the 1980s to a new New Deal order under Biden, or whether, once COVID-19 is in the rearview mirror, we will go back to the neoliberal order.

My own view is that there has been a change in American society in the direction of a recognition of the need for government to do more on the social-spending side and the climate-change side. But there has not been such a change in the Congress, because of the way the Electoral College works. Smaller states are disproportionately represented, because of the way congressional district lines are drawn – gerrymandering, in other words. So I think there is likely to be something of a disconnect between public opinion on the one hand and congressional action on the other. And for the moment, it is the congressional action that decides how much government spends and how indebted it becomes.

BE: There, I think the picture is a bit troubling. There is that political polarization, which will make running persistent budget surpluses difficult. There is the fact that there are headwinds to economic growth: less favorable demographics than we had after WWII; the fact that we don’t obviously have a backlog of technologies to take off the shelf like we did after a decade and a half of the Depression and war when there had been relatively little private investment; and the possibility that interest rates, which have been trending downward for several decades, may turn around and begin to trend upward. So that does worry me about future prospects.

I think it was exactly right for governments to do whatever it takes in response to the pandemic, even at the cost of doubling their debt loads relative to GDP. But now, I think it’s incumbent on them to restore that capacity to borrow, because there’ll be another emergency of some kind in the future – another pandemic, a climate-related emergency, a geopolitical emergency. So I think consolidating that debt inheritance is important, and it ain’t going to be easy.

BE: You’re most welcome.

Source: https://www.project-syndicate.org/podcasts/debt-wars-by-barry-eichengreen-and-elmira-bayrasli-2021-11