Draft
7/3/13
Sovereign Debt in the
Liiaht of Eternity
Lee C. Buchheit
Unsustainable sovereign debt was once seen as a unique disorder of
emerging market countries. No longer. The developed world has, in the space of
just a couple of decades, managed to submerse itself in debt stocks that approach,
and in some cases exceed, 100% of gross domestic product. The legacy of these
debts will profoundly alter life and politics in the 2lIs' century.
How might a philosopher viewing sovereign debt, as Spinoza advises,
in the light of eternity, derive the first principles governing this exceptionally
important aspect of the human condition?
I. The Moral Element
While the observance of that good faith, which is
the basis of public credit, is recommended by the strongest
inducements of political expediency, it is enforced by
There are
considerations of still greater authority.
arguments for it which rest on the immutable principles of
moral obligation. And in proportion as the mind is
disposed to contemplate, in the order of Providence, an
intimate connection between public virtue and public
happiness, Iwill be its repugnancy to a violation of those
principles.'
We tend to think of ethics as the rules or standards regulating the
behavior of individuals in their direct dealings with other individuals. Sometimes
we speak about the ethical implications of the behavior of a group of people, a nation
for example, and ascribe to it a collective morality, something that is more than just
the aggregated total of the ethical duties of the individuals comprising that group.
Only rarely, however, do we consider in ethical terms the implications of the
behavior of an entire society on people with whom they never have, nor can ever
have, direct dealings -- future generations of that society not yet born. The
despoliation of the environment is one area where we have recently grown
1
Alexander Hamilton, "First Report on the Public Credit", The Works ofAlexander Hamilton,
vol. II, page 227, 230-3 1 (Henry Cabot Lodge ed., 1904).
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accustomed to thinking in terms of such intergenerational ethics. Sovereign debt
should be another.
By its nature, sovereign debt involves the engagement of the credit of
a legal fiction -- the state -- for the repayment of money at some point in the future.
In this context, the state does not mean the goverrnent or even the citizens of the
nation as they exist at the time when the debt is incurred. It means the continuing
legal entity of the state including future governments and future generations of
citizens. Therein lies the problem. Sovereign debt involves one group of people -the incumbent generation -- borrowing money that must be paid back by subsequent
generations. The ultimate payers of the debt are not consulted about the wisdom of,
or necessity for, the borrowing. The tardiness of their birth renders them mute,
disenfranchised and powerless.
Now one might imagine that other legal fictions such as corporations
are in much the same position. The management of a corporation borrows money
today and pledges the credit of the company to repay that money at some point in the
future. When the maturity date of the loan arrives, the corporate management may
have changed, as indeed may its entire universe of stockholders. But here the
analogy breaks down. Successor corporate managers and directors, and successor
stockholders, voluntarily associate themselves with the company knowing full well
the extent of the legacy debts incurred by their predecessors. Citizens of a debtor
state do not have that luxury. A fractional responsibility for repaying the legacy
debts of prior generations will be part of the birthright of each new citizen. There is
nothing voluntary about it. To this extent sovereign debt is a congenital affliction.
Thomas Jefferson famously phrased it this way: "'[T]he earth belongs
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in usufruct to the living': . .. the dead have neither powers nor rights over it. "
Jefferson was invoking the Roman law concept of a usufruct -- the right to enjoy
property, the legal title to which belongs to someone else. Although entitled to enjoy
the property, however, the usufructuary is under a solemn duty not to sell it, to
encumber it or to despoil it. In Jefferson' s view, each generation inhabits this planet
as usufructuaries; their entitlement to enjoy the earth does not extend to the right to
deprive their successors of the same entitlement when that generation's tenure
commences. Public debts, Jefferson reasoned, are a form of encumbrance that
depletes the ability of future generations to enjoy the fruits of their labors. Why?
Because those later generations will spend a portion of their income paying back the
debts they inherited from their progenitors. "[B]y the law of nature," Jefferson
wrote, "one generation is to another as one independent nation to another."3
In the light of eternity, a heavy fiduciary responsibility therefore rests
upon the shoulders of those who incur a sovereign debt. The minister of finance
who signs a loan agreement or bond issue pledging the full faith and credit of the
2
Letter from Thomas Jefferson to James Madison (Sept. 6, 1789), in 1 The Founders'
Constitution 68 (Philip B. Kurland & Ralph Lemner eds., 2001).
SId.
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Republic of Ruritania for the repayment of a debt binds both the current citizenry of
Ruritania as well as the country's future citizens. At least the former enjoy the
consolation of having been able to vote in the election that brought the minister to
office and they will presumably benefit in some fashion from the proceeds of the
borrowing. For succeeding generations, however, the minister, the lavish signing
ceremony and the proceeds of the loan will all be historical footnotes; those
generations will experience only the distasteful residuum of the debt -- the need to
pay it back.
In practice, this fiduciary duty should translate into prudence and
restraint in sovereign borrowing. Prudence will be reflected in the motivation for the
borrowing. Some purposes are more defensible, in an intergenerational sense, than
others: borrowing to build or refurbish infrastructure, defending the state against an
external military threat and so forth. Others are less so: financing current
government expenses as a more politically palatable alternative to taxing the voting
public is an obvious example.
Restraint means preserving what the economists call fiscal space; that
is, the capacity to borrow (at tolerable interest rates) in the future. Fiscal space in
this context is the difference between the amount that the sovereign has borrowed
and the amount it can borrow. However large the appetite of a sovereign debtor, the
markets will eventually place an outer limit on the country's ability to sate that
appetite. Interest rates will rise as the country approaches its saturation point in the
credit market. Eventually, market access will be lost altogether. The sin of gluttony
does not begin at the saturation point when fiscal space has been squeezed out
altogether. It begins long before as encroachments incrementally narrow that space
and constrain the capacity of future generations to respond to whatever emergencies
may face them in their lives -- wars, recessions, natural disasters, etc.
11.
The Leaal Element
Those who are most commonly creditors of a nation are,
generally speaking, enlightened men; and there are signal
examples to warrant a conclusion that, when a candid and
fair appeal is made to them, they will understand their true
interest too well to refuse their concurrence in such
modifications of their claims as any real necessity may
demand. 4
of honor". 5
4Alexander
5
Sovereign debts are no longer, as they once were, mere "engagements
Since about the middle of the 20'h century, sovereign debt contracts have
Hamilton, supra note 1 at 230.
Here is how an English judge summarized the law of sovereign debt, circa 1876:
The first and most important point we have to decide is what the
meaning of the bond of a foreign government given to secure the
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been enforceable at law. The old doctrine of absolute sovereign immunity
(sovereigns could not be sued in foreign courts without their consent) gave way to
"6restrictive" immunity -- when behaving as commercial actors sovereigns will be
treated (more or less) just like commercial actors and held legally accountable for
their contractual undertakings.
There can be little doubt that this doctrinal shift from absolute to
restrictive sovereign immunity played an important role in the huge increase in the
amount of private sector lending to sovereigns in the last half of the 20'h century. A
few intrepid private sector parties had financed sovereigns before this shift, but
never confidently, never in size, and often with remorse. The erosion of sovereign
immunity has given the financiers of our era at least a theoretical avenue of redress.
Sovereignty (in the sense of being above the law) is a vestigial concept, and so it
should remain.
To say that sovereigns should be accountable in municipal courts for
their debt contracts, however, is not to say that municipal courts are an appropriate
forum for administering a sovereign debt crisis. Judges, powerful as they may be
within the four walls of their own courtrooms, are ill-equipped and ill-positioned to
decide how the discomfort of a financial crisis should be apportioned among the
citizens of the debtor country and the various classes of its creditors. Judges can
only hand down judgments saying that, as a matter of law, the sovereign is bound to
pay. They cannot prescribe the nature or the degree of the sacrifices that the
sovereign would need to impose on its other stakeholders in order to make those
payments or satisfy those judgments.
In the light of eternity, we have thus established a framework that
makes sovereigns accountable to the judiciary for the performance of their sovereign
debt contracts even though everyone recognizes that the judiciary is wholly
irrelevant in the face of a large sovereign debt problem. This awkwardness can lead
to considerable mischief. The theoretical availability of a legal remedy offers less
fraternal creditors an opportunity to extract preferential settlements as the price of
the sovereign avoiding the unpleasantries of a lawsuit and an unsatisfied judgment
creditor interfering with the sovereign's future commercial dealings.
payment of a loan is. As I understand the law, the municipal law of this
country does not enable the tribunals of this country to exercise any
jurisdiction over foreign governments as such. Nor, so far as I am
aware, is there any international tribunal which exercises any such
jurisdiction. The result, therefore, is that these so-called bonds amount
to nothing more than engagements of honour, binding, so far as
engagements of honour can bind, the government which issues them,
but are not contracts enforceable before the ordinary tribunals of any
foreign government, or even by the ordinary tribunals of the country
which issued them, without the consent of the government of that
country.
Twycross v Dreyfus [ 1876 T. 177] (judgment of Jessel M.R.).
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Much of the headline commotion in the realm of sovereign debt has
its genesis in this awkward situation. On the one side are the sovereign debtors who
can, with a degree of justification, portray themselves as the victims of a gang of
opportunistic, mercenary and self-righteous creditors looking to exploit the
sovereigns' vulnerability to legal remedies. On the other side are lenders who can,
with a degree of justification, portray themselves as the avenging angels that bring
discipline and accountability to feckless, corrupt or incompetent governmrent
administrators. And in between sit the large majority of creditors whose sole interest
is in preserving as much value as possible for their assets, and the debtor country's
official sector sponsors whose primary interest is in containing the political and
economic turbulence that inevitably attends a sovereign debt crisis.
III.
The Financial Element
Persuaded, as the Secretary is, that proper fuinding of the
present debt will render it a national blessing, yet he is so
far from acceding to the position .. . that "public debts are
public benefits" -- a position inviting to prodigality and
liable to dangerous abuse -- that he ardently wishes to see it
incorporated as a fundamental maxim in the system of
public credit of the United States, that the creation of debt
should always 6be accompanied with the means of
extinguishment.6
Borrowing money can become a hideous addiction. As we all know,
the United States eventually ceased heeding the advice of its first Treasury Secretary
Alexander Hamilton (quoted above) that the incurrence of public debts should be
accompanied by the means of their extinguishment. In modem practice, the normal
means of extinguishing a public debt is to incur another public debt, the proceeds of
which are used to redeem the maturing obligation. The idea that a government's
general (not borrowed) revenues would be sufficient to retire -- often even to service
-- outstanding debts is risible. Moreover, year after year, government budget deficits
require additional borrowings, over and above what is required to repay the maturing
outstanding debt. Relentlessly, remorselessly, sovereign debt stocks accumulate.
All of this is well known to both the markets and the politicians. No
purchaser of a sovereign debt instrument today does so in the hope and expectation
that when the debt matures the borrower will have the money to repay it. The
purchaser does so in the hope and expectation that when the instrument matures the
borrower will be able to borrow the money from somebody else in order to repay it.
This is a crucial distinction. If by sovereign creditworthiness we mean that a
sovereign is expected to be able to generate enough revenue fromn taxes or other
sources to repay its debts as they fall due, then most countries are utterly insolvent.
6
Alexander Hamilton, suipr note 1 at 283. In the next paragraph of his Report to Congress,
Secretary Hamilton proposes that revenues from the Post Office be set aside to provide for
"the discharge of the existing public debt".
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Sovereign creditworthiness today means market access, the ability to tap new (or
old) sources of credit in order to refinance existing debt stocks. All derivative terms
used in the sovereign debt context must be understood accordingly -- "debt
sustainability", "supportable debt load", indeed even "solvency" itself must be
understood as the capacity to refinance, not the capacity to pay out of current
revenues.
Therein lies the problem. Market access can be interrupted by many
factors, only some of which relate to the sovereign borrower. A general downturn in
world markets, an unsettling international political event, a rise in interest rates, a
loss of confidence in a currency, the misfortune or misbehavior of a sovereign
elsewhere in the world -- any of these can cause markets to turn skittish and arthritic.
And when they do, a sovereign's ability to refinance maturing debt can evaporate.
The result is a sovereign debt crisis.
In the light of eternity, we have allowed a financial system to develop
for sovereigns that assumes a more or less perpetual state of benignity -- in the
debtor country, in the region, in the global economic and political environment and
even in the natural world. A disturbance in any of these areas, if it frightens
investors sufficiently, risks interrupting the expectation of refinancing that defines
sovereign creditworthiness. Many sovereign borrowers would last only a few
months, some only a few weeks, if shut off from the ability to refinance their
maturing debts. Denied continued market access, they would burn through their
reserves with frightening speed. The last step is, for the fortunate borrowers, an
official sector bailout, and for the unfortunate a debt restructuring.
Millennialists aside, true believers in perpetual benignity are rare.
Bad things will happen. Market access for sovereigns will occasionally be lost. For
a lightly-indebted country that wants to borrow for some purpose or other, these are
inconveniences. For a heavily-indebted country that needs to borrow regularly and
in sizeable amounts in order to refinance maturing obligations, however, these hard
facts of life can spell catastrophe. The European debt crisis that began in 20 10
shows just how quickly options can narrow. The peripheral European countries that
lost market access in that crisis (as of this writing, Greece, Ireland, Portugal and
Cyprus) sat like chicks in a robin's nest in springtime -- beaks gaping, yelping for
someone to provide the funds needed to refinance their maturing debts. Terrified of
letting a Eurozone member default on its debts, the other members of the Eurozone
(together with the IMF) had no choice but to become themselves the refinanciers of
last resort. It was a story of heavily-indebted, budget-deficit countries propping up
even heavier-indebted neighbors, with the primary objective of camouflaging for a
while longer the inherent fragility of the system.
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IV.
The Political Element
[T]hese [are] plain and undeniable truths:
That exigencies are to be expected to occur, in the affairs of
nations, in which there will be a necessity for borrowing.
That loans in time of public danger, especially from foreign
war, are found an indispensable resource, even to the
wealthiest of them.
And that, in a country which, like this, is possessed of little
active wealth, or, in other words, little moneyed capital, the
necessity for that resource must, in such emergencies, be
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proportionably urgent.
Politicians who inherit an outstanding stock of debt that must
regularly be rolled over can't be criticized for authorizing those borrowings.
Discretion, and the possibility for criticism, will appear in the decisions to finance
new projects or to finance budget deficits. In these areas politicians have a choice.
The choice, however, is likely to be more political than financial.
Democracies, all of them, struggle with these realities
--
" politicians like to be elected and re-elected;
*
spending money on public services and entitlement programs
increases the likelihood of being elected or re-elected, even if the
aggregate amount of those public expenses exceeds the nation's
current income (a budget deficit);
" taxing the electorate to pay for a budget deficit diminishes the
likelihood of election or re-election; and therefore
" borrowing to cover a budget deficit is usually the only politicallyacceptable alternative.
This is the hard political reality of sovereign debt; borrowing is
almost always preferable, in a political sense, to taxation or frugality. Moreover, the
time never seems appropriate to rein in these tendencies. In good times when the
economy of Ruritania is booming only a killjoy worries about the size of the
Ruritanian debt. After all, an ever-expanding Ruritanian GDP will be able to
support an ever-expanding debt. And in bad times, recessions or depressions,
borrowing for'economic stimulus programs will be prescribed as the only way to
return vibrancy to the economy and employment to the unemployed.
Various methods have been tried over the years to curb the tendency
of politicians to borrow rather than take politically unpopular measures to eliminate
7
Alexander Hamilton, spra note 1 at 228.
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budget deficits. These include statutory debt ceilings, legislated "pay as you go"
requirements, deficit limits for countries in a monetary union (backed up by
monetary penalties), and so forth. They are the equivalent of a dieter taping shut the
refrigerator door. But somehow the tape always seems to be dislodged in the
morning.
Once upon a time in some countries, the United States is one, the
main constraint upon this feature of weak political flesh was cultural. Running up
debts to pay for current expenditures except in times of emergency just struck most
people as wrong; it was a violation of the intergenerational covenant that Thomas
Jefferson wrote about in 1789. Our collective willingness to tolerate chronic budget
deficits during peacetime is a phenomenon of the last forty years or so. It is, in truth,
just one example of a society that has become inured to heavy debt loads at every
level -- governmental, corporate and personal.
Excessive sovereign debt, however, is particularly pernicious. Even a
large country like the United States will insensibly begin to lose some of its
geopolitical influence as its national debt grows. This is in part attributable to a
perception by citizens and foreigners alike that the country may be running out of
fiscal space; that it may not be able, as it once was, to finance unlimited defense
requirements or to offer generous monetary support to allies. In Alexander
Hamilton's day, foreign credit was essential to the young American republic. His
First Report on the Public Credit, portions of which have been liberally quoted in
this chapter, had as one of its principal goals the shoring up of the credit standing of
the new nation in the eyes of foreign lenders. Secretary Hamilton would no doubt be
appalled to learn that 223 years later the prosperity of the United States is once again
heavily dependent on the generosity of foreign creditors. It is doubtful that he would
renew the title of "a national blessing" upon a debt stock whose continued servicing
is critically dependent upon that generosity.
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