Monday, March 1, 2010

Sovereign Default

A number of economists have been warning recently of possible sovereign debt default because of growing deficits.

Here is a link for a post that argues convincingly that only nations whose debt is denominated in foreign currencies are likely to default.

The article argues that no nation with a fiat currency (not backed by gold) has ever defaulted on its debt for economic reasons when that debt has been denominated in its own currency (because the nation can simply print more money).

The sovereign defaults of developing nations that have occurred since WWII primarily did so because they were forced to borrow money (e.g., from the IMF or World Bank) in foreign currency.

This type of situation is part of what ails Eastern European home borrowers whose mortgages were denominated in foreign currency (e.g., Euros). When capital flight hit Hungary, for example, the value of Hungarian currency declined relative to the Euro. So, borrowers in Hungary had to pay more of their local currency to repay debt denominated in Euros.


The primary reason this entire discussion matters is because many countries, including the US, are being pushed by deficit hawks to enact "austerity" measures. Austerity almost always translates into reduced social-welfare benefits, such as health and education spending. For some reason, military spending is never targeted in austerity measures....

So, the idea that the US needs to chop social spending in order to reduce deficits is based on false assumptions. Cutting military spending, on the other hand, sounds like a good idea....

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