Sovereign Debt Crisis: Who owns the public debt?

The “Markets” control of Sovereign debt of Greece and other Eurozone countries poses a threat to financial stability

Recent data on the state of the global economy indicate clearly that the crisis is not over. Contrary to earlier   assessments it now appears that in the years to come the developed economies are bound to experience,  a deep recession. Hence the calls for the adoption of austerity measures and the debate concerning the wisdom of adopting such measures which took place in the last G20 summit.

The proponents of austerity, in particular the Republican Right circles in the US, concentrate their political wrath on Public Debt. They perform an audacious rhetorical spin, when they present the collapse of the private financial sector as a result of governmental fiscal profligacy. In this debate the fiscal hawks have a powerful ally: the “Markets”.

The “Markets”

In the discourse on policy in a market economy the response of the “Markets” and its implications is always taken into account. During the last 30 years, small elite of macro-economic policy makers has created a perception of the “Markets” as being a global amorphous entity which is both all-knowing and above politics. The financial crisis ended that myth. As the financial crisis unfolded, the “Markets” were more clearly seen as the “financial markets. The mere fact that names mentioned in relation to the financial crisis were Goldman, Lehman, AIG etc. exposed the fact that “Markets” are not driven by a neutral mechanism reflecting independent choices of million of investors around the globe. Rather it is an amalgam of organizations and their managers who finance experts and decision makers, and who in turn, influence stock exchanges. A key to the to the understanding of how the “Markets” can pressure governments to adopt fiscal policies which run contrary to their economy’s interest lies in understanding the process by which the financial markets became the owners and masters of Public Debt.

The financial roots of Democracy

In his book “A Free Nation deep In Debt” James Macdonald describes how the evolvement of the Public Debt is inextricably linked to the evolvement of modern Democracy. Public debt owes its origin to the realization of absolute rulers that wars are more easily financed by borrowing from the ruler’s own subjects than from foreign powers or from lending organizations.

The dependence of a regime on its subjects gradually gave the latter a greater say in running the country, giving rise to the “citizen-creditor” and to Public Debt as the financial foundations of democracy. In a democracy public debt (in the domestic currency) is formally and institutionally the obligation of the nation to its citizens. The very same citizens are also the guarantors of the Debt. A country is not a limited liability company. The citizen-creditor is at the same time the shareholder and the obligor even if the Debt is owned by foreigners. He has trust in his government which in return is accountable to him.

The level of public debt is a key question of economic policy. The “citizen-creditor” will monitor the conduct of its government to prevent it from entering into adventures that may jeopardize the value of its debt. By the same token if the utilization of funds borrowed by the government from its citizens is democratically approved, the citizens view their government debt as risk –free, regardless of how such debt might be rated by any foreign agency. In a monetary union like the EMU, there may be additional restrictions imposed on a member country, as part of that union’s policy. That is how public debt has become the anchor of wealth of both individuals and organizations in a democracy. The social security, life insurance and pension funds all rely on government debt as fully secured obligations.

The Bank of International Settlement, [BIS] which formulates the standards of Capital Adequacy of Financial Institutions (Basel) authorizes the regulators in any country that abides by the BIS standards, to qualify its government obligations as risk-free. Thus banks and insurance companies do not have to allocate capital against exposure to their own government. Hence the stability and much of the profits of financial institution depend on government debt.
It begs the questions how the “Markets” managed to impose on the global discourse regarding the Public Debt a terminology which is taken from the contexts of “default” and “bankruptcy” of corporations, or from that of the Paris Club, where external debts of debtor countries are arranged and restructured. Greece has been compared to Lehman Bros. and to Argentina. Both comparisons are utterly wrong.

The declining status of Public Debt

The declining status of Public Debt is the story of the global economy of the last three decades. The election of Reagan as president in 1980 ushered in a US administration openly hostile to any involvement of Government in the economy. The implied economic policies which have been implemented hinged on two sacrosanct elements: cutting taxes and limiting public debt.

Those principles became the foundations of the macro-economic orthodoxy prevailing in the US. Gradually the same principles became the quintessential characteristics of “good and right economics” in the rest of the world as well.

The policies drawn from such principles, favored the wealthier sections of society who were less dependent on government services. Their share of the national income grew dramatically the level of wealth of the less wealthy strata remained stagnant. Government was increasingly less able to meet the needs of the weaker sectors of society. The wealthy who were exempted from paying taxes had no interest in lending to their government. That left the Government with no other choice but to borrow in the “Markets”. As a consequence the financial burden of running a country fell more heavily on the less wealthy, and the Markets became the masters of Public Debt.

To illustrate how dramatic the change in ownership has been one should note that by the end of WW II, the US public debt was twice its size today, in terms of GDP, The American citizens owned just about all of it. Today, US citizens hold directly only 10% of US Government debt. James Galbraith in his review of Macdonald’s book aptly raises the question: “Can democracy survive when its financial roots have been cut? The scale of public debt is not the issue, but its ownership is. Can a country–whether the United States or any other–be truly democratic if it is in hock to banks and foreigners?”1

The “Markets”- a risk to stability

The Eurozone crisis showed us that ‘Markets’ ownership of public debt may even be a risk to the stability of the global banking system.

Greece’s government debt in its own domestic currency was downgraded to “Junk”. Due to the regulatory regime of the Eurozone, such downgrading creates a situation where a bank in one of the Eurozone countries that holds his own government bonds regard them as risk-free, like any other country, and may even collapse because of the downgrading. The absurd may even be greater since the Government that will need to bail out such a bank, is the very same government whose downgrading brought down the bank in the first place. Such a situation would be in total violation of the existing Basel framework and will make the implementation of the new framework (Basel III) difficult If not impossible.

Indeed the “Markets” showed that they are willing and able to destabilize the entire European banking system on account of their alleged undisclosed holdings of government debt of certain Eurozone countries. They do so with assistance from the “Bloombergs”- a generic name I propose for the media platforms through which they deliver their “message” to the exchanges. Luckily the ECB has so far withstood the pressure and continued to relate to Greek sovereign debt as if that debt was not downgraded.

The citizens should reclaim control of Public Debt.

The citizens in the democratic countries need to reclaim control of their government debt in order to revitalize the democratic institutions that have been weakened in the last three decades. Furthermore, the prolonged recession may require governments to reach decision of unprecedented importance. For example, opting for a continued assistance to the unemployed and maintaining at least minimally decent living standards, in order to preserve the social fabric of a society, is a choice of no lesser importance than, for example, going to war. Both choices may involve passing a significant debt burden to future generations. These are not purely economic dilemmas. Such decisions should be debated and decided within the political discourse in the appropriate democratic institutions and not within the boardrooms of rating agencies or under a constant threat from the “Markets”. The primary lesson from the current crisis is that a country should never be too dependent on the “Markets” to finance its operations.

It’s easy said and (fairly) easy done.

A country can borrow directly from its citizens in the same way that it collects taxes from them. Such borrowing may be voluntary or mandatory.

Mandatory borrowing is a practice adopted by governments from time to time, especially at times of emergency. France is currently preparing a major State Loan (Emprunt d’État) called Le Grand Emprunt . The borrowed funds will be used for “investment in the future”. Among the center-right UMP ruling party there are those who advocate making such loan mandatory (obligatoire).They hope that it may preempt the likely political pressure to raise taxes on the wealthy.

Greece too can and should be able to borrow directly from its citizens.
Now that the Eurozone countries provide Greece with protection from the “Markets” for at least two years, it should organize a State Loan whose purpose will be to repurchase the tradable sovereign bonds from the concerned “Markets” . Such a loan will not increase the overall level of Greece’s public debt and will help it regain its sovereignty over its fiscal affairs and its status and respect among its fellow Eurozone members.

I doubt very much if at the current yields there will be many sellers of Greek government debt. As soon as the “Markets” realize that Greece can manage without them, their assessment of Greece risk profile will suddenly change. They are in the business of sovereign debt because it is very profitable. In my assessment they will fight to retain their share of that business.

1 http://www.democracyjournal.org

2010-12-05  »  ehud