The many faces of government failure

Although sovereign debt is a preferred asset class around the world, it has had a colorful history of over 200 defaults over the past two centuries and continues to this day.

This record reflects an ongoing political temptation that the sardonic observer of sovereign defaults, Max Winkler, memorably described in 1933. Zambia, both governments defaulted again in 2020 – “Tomorrow they may be dismissed from office. Today they can only live if they give in to multiple expenses. . . and to exchange favors through the abuse of the treasury. To enjoy the present, they happily mortgage the future. “Of course, we can’t read this without thinking about Biden’s $ 1.9 trillion project that needs to be spent, borrowed, and printed.

Historically, the booming national debt around the world has often led to “national bankruptcy and default”. Winkler recorded the long list of government failures well into the 1930s. He predicted that future investors would look “sad” again at unpaid government promises to pay. He was so right. Since then, the list of sovereign failures has grown much longer.

A quick quiz: here are six sentences of years. What do they represent?

  1. 1827, 1890, 1951, 1956, 1982, 1989, 2001, 2014, 2020
  2. 1828, 1898, 1902, 1914, 1931, 1937, 1961, 1964, 1983, 1986, 1990
  3. 1826, 1843, 1860, 1894, 1932, 2012
  4. 1876, 1915, 1931, 1940, 1959, 1965, 1978, 1982
  5. 1826, 1848, 1860, 1865, 1892, 1898, 1982, 1990, 1995, 1998, 2004, 2017
  6. 1862, 1933, 1968, 1971

All of these are years of failure by a sample of governments. They are each the governments of:

  1. Argentina
  2. Brazil
  3. Greece
  4. Turkey
  5. Venezuela
  6. The United States.

In the case of the United States, the default policy was to refuse to redeem promised gold or silver bids in 1862; the refusal to redeem gold bonds for gold as promised in 1933; the refusal to redeem silver certificates for silver as promised in 1968; and the refusal to honor the dollar claims made by foreign governments for gold in 1971.

With the outbreak of civil war in 1861, the war effort proved far more costly than previously thought. In order to cover the costs, the congress approved a circulating currency in the form of “demand forms”, which could be redeemed in precious metal coins at the request of the holder and which promised this at first glance. Treasury Secretary Salmon Chase stated, “To be convertible into coins at any time at the option of the holder. . . They must always be synonymous with gold. “But soon after, in early 1862, the US government was unable to honor such withdrawals and so stopped doing so. In order to support the use of banknotes anyway, Congress declared them legal tender that had to be accepted to pay off debts. Speaking of the issue of paper money, President Lincoln quoted the Bible: “Silver and gold I have none.”

Outstanding US Treasuries in 1933 included “gold bonds,” which clearly promised that the investor could choose to pay in gold coins. However, President Roosevelt and Congress ruled that the payment was “against public order” as promised and declined. The bondholders sued and turned to the Supreme Court, which ruled 5-4 that this is the way the government can exercise its sovereign power. Shortly before, when Roosevelt ran for office in 1932, he had said: “No responsible government would have sold securities to be paid in gold to the country if it had known that the promise – yes, the covenant – contained in those securities was. . . doubtful. “A recent history of this failure to pay as agreed concludes that it was an ‘excusable default’.

In the 1960s, the US still had real silver coins and dollar bills that were “silver certificates”. At first sight, these dollars promised that they could be redeemed for a silver dollar if requested by the US Treasury Department. But when inflation and the rising value of silver caused people to ask for withdrawals as promised, the government decided to stop honoring them. If you still have a silver certificate today that contains the government’s unequivocal promise, that promise is not being kept – no silver dollar for you. The silver in this unpaid silver dollar is currently worth about $ 20 in paper money.

A basic idea of ​​the 1944 Bretton Woods International Monetary Agreement was that “the US dollar and gold are synonymous”. In 1971, however, the US renounced its Bretton Woods Agreement to redeem dollars held by foreign governments for gold. This historic default has moved the world to a pure fiat money regime that continues to this day, despite having seen numerous financial and currency crises as well as endemic inflation. Since 1971, the US government has stopped promising to redeem its money for anything else, and the US Treasury Department has stopped promising to pay its debts with anything other than the government’s own fiat currency. This prevents nominally explicit defaults, but does not prevent high inflation and devaluation of both currency and sovereign debt from arising, which are implicit defaults.

Winkler told a pointed story to give us an archetype of national debt from ancient Greek times. Dionysius, the tyrant of Syracuse, was tough and could not pay his debts to his subjects, it is said. Therefore, he issued a decree according to which all silver coins had to be given to the government under the penalty of death. When he had the coins, he revised them: “Stamping on two drachmas per one-drachma coin.” Brilliant! With this he paid his nominal debts, became, as Winkler said, “the father of currency devaluation” and thus expropriated his subjects real wealth.

Note that Dionysius’ strategy was essentially the same as that of the United States in the default settings of 1862, 1933, 1968 and 1971. In all cases, like Dionysius, the US government has broken a promise, devalued its currency and reduced its obligations to Cost of its creditors. Standard can have many faces.

It’s that easy to be a sovereign when you can’t pay as promised.

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