Can Countries Go Bankrupt ?
- Most people think that there is no way a country can go bust. Tell them America is going bust and they will laugh at you. How can the most powerful nation in the world go bankrupt? The only superpower in the world can never ever default on its debt ! Really ?
- Well guess what? Nations do go bust. Argentina, Iceland, Mexico, Russia (remember this great superpower?) and many more have gone bust. The Roman empire became bankrupt and collapsed. Why not America? Why not the European Union? Why not the Middle East Oil power? Aren’t they suppose to be filthy rich with their inexhaustible black gold? The news is, they are in trouble because they have build their economy on US$80/barrel oil. It is now US$40/barrel. Dubai is littered with frozen real estate projects that are half complete.
- Spiegel Online International reports in Can Countries Really Go Bankrupt? :
“There’s a rumor going around that states cannot go bankrupt,” German Chancellor Angela Merkel said recently at a private bank event in Frankfurt. “This rumor is not true.” Of course she’s right. Countries can go bankrupt if they allow their deficit spending to spin out of control and are no longer able to service their interest payments. Merkel’s comments can be read as a warning that countries need to keep their deficit spending in check. The message is: If governments go too far in trying to bail out companies and the economy, they could face insolvency themselves.
And so far, national governments have gone very far. Be it in the United States or in Europe, the sums governments are having to cough up to prevent the financial system from collapse are staggering.
Germany alone has already provided credit guarantees of €42 billion ($52.28 billion) to prevent the collapse of Munich’s Hypo Real Estate, a bottomless pit that most now believe will have to be fully nationalized. The only thing holding up such a move is a legal provision in Germany that limits state holdings in banks to 33 percent. Meanwhile, Germany’s second-largest consumer bank, Commerzbank, has been bailed out, with the state taking a one-quarter stake in the company. And the recent fourth-quarter loss of €4.8 billion at Germany’s leading financial institution, Deutsche Bank, suggests that it too may ultimately require state assistance.
From Inconceivable to Inevitable
The image is even bleaker in the United States, where economist Nouriel Roubini estimates that losses in the financial sector will total $3.6 trillion. In the United Kingdom, the government has partially nationalized the Royal Bank of Scotland and Lloyds TSB — and many experts see a full nationalization as inevitable.
There are few who would disagree with such moves. Should large systemically-vital banks go bust, the global financial system would collapse. But how much can countries afford to pay before the deficit-spending bubble bursts? An unimaginable scenario? Less than a year ago, a nationalization of banks in the US, Germany and Britain would have been inconceivable. Today, even the US — the home of unbridled capitalism — sees these moves as inevitable.
- Take the example of Britain and Italy :
The country is on the brink of financial ruin. Real estate is overvalued, private households are overly indebted and its vast financial sector has been badly hit by the crisis. Confidence in Britain’s ability to overcome the economic turmoil is sinking by the day, as evidenced by the precipitous decline of the pound, which has almost reached parity with the euro. Just 13 months ago, it was worth €1.40.
A Second Iceland
“I wouldn’t invest any more money in Great Britain,” says American investor Jim Rogers. And economist Willem Buiter, a former consultant to the Bank of England, warns of the “risk that Great Britain will become a second Iceland.”
One can also look to the example of Italy, which is on track to join a rather exclusive — and undesirable — club. At 106 percent of gross domestic product, Italy will have the third-largest national deficit in the world. In a country that has long had a solid savings rate, deficit spending hasn’t proven to be a huge problem in the past. The greatest challenge the government had was luring people to buy bonds at a set interest rate. The country’s finance minister has described these investments as the “most solid and secure thing available.” Of course, not everyone shares that opinion at the moment — particularly not the Italians themselves. One bond that was floated in mid-January only found takers after the government markedly increased the interest rate offered.
- Saddled with huge debts, both America and the EU are burdening future generations with exorbitant debt repayments. At some point in time spending must be reigned in and taxes must increase. A US$10T debt at 3% amounts to interest payment of US$300B per year for America. With tax revenue of about US$ 2.1 to 2.4 T, interest payment amounts to 12 to 15% of tax revenues.
- As tax revenue collapses in the next few years, the budget deficit will rocket upwards. The deficit for 2009 will easily exceed US$ 2T. Projections into 2012 are for deficits of US$ 1T/year at least. How long can this last? This can only be financed be foreigners and they are pulling out.
- Spiegel Online again :
In a study for the International Monetary Fund, US economists Carmen Reinhart and Kenneth Rogoff researched financial crises of the last 800 years and concluded that state bankruptcies were a “universal phenomenon.” Many countries have, in fact, gone bankrupt more than once.
Between 1500 and 1800, France became insolvent eight times. Spain went bankrupt seven times during the 19th century. Insolvency is a common phenomenon in every period of history, they concluded, and it would be erroneous to think that state bankruptcies are a “distinctive feature of the modern financial world.”
In most cases the country’s coffers were wiped out by war. But in each case, the countries managed to bring themselves back from ruin. They proved to be incredibly resourceful in using their connections to banks, companies and, especially, the people.
The simplest solution was for states to just outright refuse to pay back their debts. In 1557, Spain’s King Philipp II refused to pay his country’s debts after its expensive military battles against the Dutch and the Ottomans. It was a decision that seriously damaged lender banks in Augsburg, Germany, and they never fully recovered.
- The other options for a country like America are as follows :
A similarly brutal option was to go to war to in order to plunder occupied areas. But such methods of budget consolidation tended to only happen when things started to collapse. Even in the old days, inflation was the preferred method of dealing with debt. They created more money and devaluated it. It’s a method that was adopted as early as ancient Rome, where the Romans devaluated their coins by using fewer precious metals in them. It became a standard practice. In Vienna, the silver content in the Kreuzer coin was reduced by 60 percent between 1500 and 1800 and the Ausgburg pfennig lost more than 70 percent of its value.
Once paper money was introduced, the process was further simplified, since you could just print it. The first country to start printing money on a grand scale was France in the 18th century, when it needed to pay off the mountain of debt accrued by Louis XIV. In times of crisis, French governments ever since have fallen for this temptation.
- Go to war for economic conquest or inflate your way out of the problem? Bernanke favors hyper-inflating away America’s debt. Quantitative Easing – Let’s print more money out of thin air! Would it surprise me if some knuckle headed politicians decide to engineer a WW3 to get the country out of the problem? Not at all. Some say, WW2 was engineered so that America could get out of the Great Depression.
- When countries take the option of hyper-inflating their debts away, it means currency devaluation. History teaches us :
In 1914, with the start of World War I, the German Reich also began to unpeg its currency from gold. Until then, anyone could trade paper money for precious medals. Unpegging the currency meant that the amount of money in circulation rose from 13 to 60 billion marks by the end of the war, while the products on offer were reduced by one-third. Prices skyrocketed.
The disastrous development reached its peak in 1923 with hyperinflation. The exchange rate at the time was 4.2 trillion marks to the dollar. Bank notes were printed in 130 private printing presses, often on one side only to save ink. The only thing that could stop the mass devaluation was to change currencies.In November 1923, the government issued the so-called Rentenmark. The previous currency could be exchanged at a rate of 1 trillion marks for 1 Rentenmark. Inflation quickly stopped. People spoke of the “miracle of the Rentenmark.” But the truth is that it wiped out the savings and investments of large swaths of the German middle class as well as wealthy people who had been forced to finance the war by buying government bonds that had now been rendered worthless. Banks and insurance companies also lost their capital. The greatest winner, besides people who had loans or mortgages they no longer had to pay back, was the government. Its war debt shrank into insignificance.
These traumatic events remain a part of the Germany’s collective memory and they fuel a latent fear of hyperinflation here today. Should people be afraid?
- Spiegel Online asks :
So will things get better? It would be an illusion to believe that countries have learned from their past mistakes, US economists Reinhart and Rogoff warn. In fact, another state could go bankrupt at anytime and take its people down with it.
In this crisis, nothing is unimaginable anymore.
- Will more countries go bust? Yes, without a doubt. Will America and Britain go bust? Yes! So will many EU countries and G20 countries! We are heading towards global insolvency. See also :
GEAB : Systemic Economic Crisis: The Sequence of Global Insolvency Begins
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