Loans to a King do not always pay


The market panic began when the US succeeded in reaching settlement, not when it failed to do so. There is sense in this: the debate about the debt ceiling accelerated recognition that sovereign debt repayment is more about politics than economics.

Businesses and individuals pay their debts because they have to, but sovereign borrowers are in a different category. Sovereign immunity follows the logic of sovereignty. The courts impose the authority of the king and, therefore, cannot be used against the king.

The considerable assets of governments are generally not available to their creditors. Some arrangements pretend to bypass this principle – the UK Treasury building is the subject of a complex securitisation and the Athens metro might be privatised. But anyone who imagines that such security could be enforced is living a dream.

The spat between Standard & Poor’s and the US Treasury over accounting numbers similarly misses the point. The issue is not, and never will be, the capacity of government to repay; the issue is the willingness of government to repay. If sovereign borrowers meet their financial obligations, it is only because they want to.

For centuries people realised that the special status of the sovereign made lending to the king risky: rich individuals and sound ventures were generally safer investments. Kings could default, or pay in devalued coin, and there was nothing the angry lender could do about it. The sovereign lender must not only risk his capital but brave the ingratitude that borrowers often display.

When Walter Wriston observed of third world lending that “countries can’t go broke” he was describing a problem rather than an opportunity. If borrowers did offer to repay, that was generally because they wanted to borrow more. And borrowers did borrow more until their repayment capacity ceased to be credible.

Richer countries seemed a better bet because their citizens felt an obligation to meet public debts. But that sense of obligation based on a shared sense of the legitimacy of the obligation has recently been eroded.

In Iceland and Ireland, the public does not readily understand why it should be responsible for the follies of financiers. In the US, a minority seem to believe the federal government represents a hostile occupying power. Europe suffers from deliberate blurring of the distinction between the obligations of individual states and the obligations of the eurozone. These different phenomena are all manifestations of the same underlying cause – loss of confidence in governments and trust in the financial system.

The legal doctrine of sovereign immunity extends to foreign sovereigns. If the English courts would not enforce judgments against the king of England they would also decline to enforce them against the king of France. Partly from chivalrous reciprocity but also from pragmatism. Such enforcement could turn a private transaction into a war between states.

And could do so even today. Imagine a hedge fund seeking a sequestration order against Air Force One on the tarmac at Heathrow. State debt owed to foreigners and foreign ownership of key national assets have regularly created political problems. Think of the constant destabilising impact of economic colonialism in Latin America, the failed attempts to extract reparations from Germany after the first world war, the impact of petrodollars on the politics of the Middle East. Today we have to think about Asia’s holdings of US bonds and the rise of sovereign wealth funds. In each case the interaction of economics and politics damages both sound economic policy and good international relations.

We have finally realised that these historic problems have not been solved by modern capital markets. Some hedge funds have done well by understanding the nexus between commercial reality and geopolitics. But most sovereign debt is now in the hands of traders with little knowledge or understanding of history, politics – or much else, with no sense of responsibility. We are all feeling the consequences.

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