While Greece’s debt problems never seem to be long absent from current headlines, sovereign debt crises have been happening for centuries. In their comprehensive work This Time is Different (2009), Carmen Reinhart and Kenneth Rogoff surveyed eight centuries of financial crises and calculated that only 17 sovereign nations had never defaulted on, or engaged in rescheduling of, their external debt since independence or 1800. “Serial default,” they write, “on external debts is the norm throughout every region of the world”—which means, Reinhart observed in a recent article, that we should be prepared for more sovereign debt crises.
Sovereign debt involves governments soliciting capital loans in return for which they agree to make interest payments to creditors at designated periods until an expiration date upon which the principal is repaid to creditors. Discussions of sovereign debt crises invariably focus on the likely economic and political impact of a government’s incapacity to pay what it owes. Greece is a small country with a small economy. The inability of successive Greek governments to resolve their sovereign debt problems receives outsized attention because of (1) the political significance for the single currency project of a euro member state defaulting and (2) fear of contagion. To the extent that questions of justice concerning the resolution of debt crises are directly engaged today, this more often occurs when private creditors take governments to court to secure what they believe they are rightfully owed.
This raises important questions: What is the most reasonable framework through which governments should try to address such matters? Should they try to resolve them through appeals to necessity and pragmatism? Or should they seek more principled approaches that take justice seriously? If so, where may such methods be found?
Expediency Often Fails
The scenes of chaos that engulfed the streets of Buenos Aires between 2000 and 2002 exemplify how the impact of sovereign debt crises goes far beyond the financial. In his account of Argentina’s debt crisis, financial journalist Paul Blustein vividly portrayed how the unfolding calamity affected ordinary citizens: from the working-class factory worker who lost his job and was reduced to picking his way through the trash to find objects suitable for recycling, to middle-class professionals who became underemployed, struggled to pay their bills, and saw their house values plummet.
In such situations, governments often respond by acting in morally questionable ways. Not long before Argentina defaulted in 2001, for instance, the government seized pension funds and converted them to treasury bills. Whatever promises had been made to millions of pension-holders were summarily cast aside as the government scrambled to find the resources it needed to avoid defaulting.
As shocking as it may seem, some commentators would contend that such actions are within the remit of governments. Thomas Hobbes, for instance, argued that the sovereign ultimately decides through the laws that he makes who is the rightful owner of property. Thus the state could legislate for the expropriation of private property to help pay its debts, or even declare that it simply no longer wishes to pay its debts. In Hobbes’s schema, what would prevent governments from acting in such ways would be not a commitment to justice but rather attention to their longer-term self-interest: the knowledge that defaulting on sovereign debt would damage the state’s capacity to access capital loans in the future.
Yet the sheer number of sovereign debt defaults and repudiations throughout history suggests that self-interest has not always deterred governments from unilaterally altering or disavowing the terms of debt agreements into which they have freely entered. As Adam Smith commented in his Wealth of Nations:
When national debts have once been accumulated to a certain degree, there is scarce . . . a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by a bankruptcy: sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.
By “pretended payment,” Smith had in mind currency devaluations, the injustice of which he was not slow to underscore. These, Smith said, enriched “the idle and profuse debtor at the expense of the industrious and frugal creditor.”
Moreover, considerable evidence shows that in many cases when states default, they quickly regain access to capital markets at interest rates that don’t reflect the history of their previous misdeeds. One of the first actions taken by the Bolsheviks after seizing power in Russia in 1917 was to repudiate approximately 30 million tsarist bonds issued between 1827 and 1917. Yet by the mid-1920s, the Soviet Union was receiving capital loans from American businesses—despite the US State Department officially barring such loans because, in the words of Secretary of State Charles Hughes, providing such credit would “give encouragement to repudiation [of debts accrued under the previous tsarist government] and confiscation [of private property].” Repudiation, it seems, did not hinder the Communist regime from acquiring new sources of credit.
Justice in a Crisis
Adam Smith argued that, for states facing insolvency, “a fair, open, and avowed bankruptcy is always the measure which is both least dishonorable to the debtor, and least hurtful to the creditor.” Smith’s use of words like “fair,” “open,” and “dishonorable” underscores his awareness that questions of justice are involved. Bankruptcy law itself involves the application of principles of distributive and commutative justice to cases of insolvency.
Though bankruptcy is occasionally suggested as one way forward, at present there is no bankruptcy procedure for sovereign states. There are, however, political actors and thinkers who have sought to outline frameworks for addressing these matters that go beyond pragmatism. One notable example is America’s first treasury secretary, Alexander Hamilton.
Confronting the challenge of solving the immense debt problems facing the young republic, Hamilton underscored that there would be occasions in which governments’ responsibility to meet debt repayments would not or could not be realized in perfect concordance with their formal obligations. Faced, for example, with external military aggression, it would be reasonable for a government to accord a lower priority to debt repayments as it rearranged its finances to meet the threat. Clearly Hamilton understood that concern for the polity’s well-being cannot be reduced to the fulfillment of contracts.
That said, Hamilton did not think that sovereign states should behave in a cavalier fashion with regard to debt, even when confronting sudden and expensive contingencies. Part of his reasoning was economic self-interest. Any breach, Hamilton wrote, “of the public engagements, whether from choice or necessity, is in different degrees hurtful to the public credit.” Nonetheless, Hamilton also argued that unilateral adjustments to sovereign debt payments had to be directed “by a scrupulous attention, on the part of the government, to carry the violation no farther than the necessity absolutely requires, and to manifest, if the nature of the case admits of it, a sincere disposition to make reparation, whenever circumstances can permit.”
Public Welfare as the Common Good
It would be easy to regard Hamilton’s exhortation as another appeal to expediency—save for the fact that Hamilton insisted there were “considerations of still greater authority” applicable to the sovereign debt question, these being directly derived from what Hamilton called “immutable principles of moral obligation.” By obligation, Hamilton partly had in mind the moral debt that America owed to those who had bankrolled the revolutionaries’ struggle for independence. The language deployed by Hamilton, however, also implies a type of natural-law discourse. It is very likely that Hamilton had in mind the eighteenth century’s preeminent natural-law theorist of international law, Emer de Vattel, whose most famous book The Law of Nations influenced many American Founders.
In this text, Vattel contended that loans contracted by sovereign states in order to meet the nation’s needs were “contracts in all the strictness of law, and obligatory on the state and the whole nation, which is indispensably bound to discharge such debts.” It was, he argued, irrelevant whether the acquired capital was spent wisely or squandered by the debtor state. In Vattel’s view, “the nation is bound to restore it to [the creditor],” regardless of whether it is a private creditor or a loan extended by another sovereign state.
Does this mean that countries facing severe fiscal challenges must immolate themselves on the altar of debt repayment? Vattel’s answer is a distinct “no.” If fulfillment of a contract by the state “proves inimical to the public welfare,” then “the sovereign may rescind those contracts.” The key here is the idea of the public welfare. In the law of nations tradition within which Vattel worked, this didn’t involve a grand utilitarian calculus. Rather, it was a synonym for the common good.
Vattel’s conception of the public welfare does not therefore function as a get-out-of-jail-free card for governments anxious to extricate themselves from debt obligations they would rather not fulfill. Why? First, to Vattel’s mind, the public welfare—as Hamilton seems to have grasped—tells us that governments should only depart from debt obligations to the extent absolutely necessary to guarantee “the safety of the state.” Second, Vattel insists that in such cases “indemnification is due” to creditors sometime in the future. By contrast, there is nothing in Hobbesian approaches that, on the basis of principle, would require states to make reparations. In short, reasonable fulfillment of contracts by governments is, from Vattel’s standpoint, a condition of the common good that sovereign states are not free to ignore or trivialize, even in extreme circumstances.
For the foreseeable future, it seems unlikely that those charged with resolving sovereign debt crises will be guided by a notion of the common good that does not confuse the requirements of justice with doing whatever seems convenient at the time. The payment of lip-service to “thick” understandings of the public welfare, I expect, is the most we can expect. If, however, governments ever decide to move beyond the treacherous waters of pragmatism—a path often grounded upon Hobbesian theories of state authority that consequently produce Hobbesian responses—when facing such crises, it is worth knowing that there is another more coherent and therefore less arbitrary tradition for them to follow.
Samuel Gregg is Research Director at the Acton Institute.