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Our D-Word: Ecuador, Not Greece

posted by Anna Gelpern

In the inane and insane case the United States does skip a debt payment, please let us skip the comparisons to Greece. Greece is really out of money and probably should have bitten the D-bullet (restructured, re-profiled, whatever) some time ago. We are not out of money, yet might default anyway--which makes us surreally more like Ecuador circa 2008.  Like Ecuador's recent D-dalliance, a U.S. failure to pay would be purely discretionary, a rare case of unwillingness, not inability, to pay.

Quick review:  sovereign debt is debt with limited enforcement capacity. Sovereigns are immune; therefore, if they default on their debts, creditors will find it virtually impossible to collect.  Case in point: Argentina defaulted on about $100 billion in 2001; ten years and thousands of lawsuits later, there has been one attachment of a few million dollars (not sure if anyone has actually been paid). This leads to a theoretical conundrum: if they can default with impunity, why do governments ever repay? (... and why does anyone lend to them?) Mysteriously, even the most hopelessly overindebted governments tend to pay their debts in full and on time until the bitter end, often at a high cost to their economies. The policy challenge has been to get governments to restructure sooner, not to pay better. 

The usual answer to the conundrum is that governments worry about their market reputation, and also a dash about enforcement (defending lawsuits and squirreling away assets is a headache, even if you win in the end). But a much, much more interesting explanation comes out of recent empirical research. It turns out that overindebted governments are most worried about the domestic implications of default: bank runs, currency plunges, riots, revolutions, and such. Governments really hate bank runs and revolutions, and so keep paying until the money runs dry and then some. 

That is why virtually all sovereign debt restructurings seem to come of credible inability to pay, as measured by conventional metrics, such as debt/GDP, debt/exports etc.  Pure unwillingness to pay is wildly rare. Ecuador is arguably the closest it has come in recent years. Although its medium-term prospects were not all rosy, in late 2008, Ecuador had enough oil revenues to make the foreseeable debt payments. Nevertheless, the new government made the political decision (which I discussed here) that much of the debt stock was illegitimately incurred, and told the creditors it would not pay them. With bond prices down on the announcement, Ecuador launched a successful debt buyback a few months later, and got substantial debt relief.

Similarly (!), the United States is not now running out of money, though some might argue about its medium-term prospects if nothing is done about taxing and spending. Defaulting now to make a point about our medium-term prospects is pure unwillingness to pay--indeed, our case would be even purer than Ecuador's.

If all goes to plan, in just a few days or weeks, Ecuador and the United States will go off into the sunset, united in our plunging common currency and theoretical significance for sovereign debt studies.  We shall teach the world a lesson: that rich or poor, sovereign ability to pay will always be a function of domestic politics, and awfully hard to tell apart from sovereign willingness to pay ... except when you are really rich.


"In a recent interview with POLITICO, David T. Beers, head of sovereign ratings at S&P, said the July 14th report was not a major shift and simply reflected an increased concern that there is no clear path to significant deficit reduction.

“What we are focused on is not the debt ceiling but the underlying state of public finances,” said Beers, a London-based executive who has conducted multiple meetings with administration officials.

In order to maintain a triple-A rating, Beers said, “what would have to emerge would be something that has a material impact on the underlying fiscal issues.”

The obvious solution: spend more! Paul Krugman agrees.

There's still a significant difference between Ecuador and the USA in that it's virtually assured that the US will pay out its debt at par, even if it's a couple days or weeks later. Meanwhile, Ecuador has no intentions of doing the same.

Unwillingness to pay isn't all that rare, especially at the municipal level. It stems from an unwillingness to tax rich people. Orange County and Nassau County are examples. California and the US are seeking to join that club.

Maybe we should skip some payments to China to test the practical limits of sovereign "immunity" in this context...

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