Wavepacket Blog

Wavepacket Blog
only displaying 'economics' posts

Sun May 9 20:52:16 2010
Sovereign Bankruptcies
What really happens when countries go bankrupt?

Spain celebrating peace, just before running out of money.
Image courtesy of Razr (wiki)

I've been wondering about this for a while. How do sovereign countries go bankrupt, and what happens when they do? So I decided to find out.

I am mostly (and selfishly) worried about the United States. We seem to be unable to constrain our spending, meaning that we have to borrow a lot of money. Whenever you keep borrowing money, whether you are a person, a company, or a country, eventually people get tired of lending money to you. Over time, people stop lending, or lend at ever-higher rates. At some point you either pay off your debts and live within your income, or you go bankrupt.

But lately this has come up several times for countries besides the US. Iceland nearly went bankrupt 2 years ago, and now Greece could go bankrupt, and some say Portugal and Spain may not be far behind.

What with talk of bond markets and "contagion risks" and riots, it can all look very complicated.

But really, bankruptcy is very simple. If you can't pay your debts, then you are bankrupt. You have to pay what debts you can, and the rest are left forever unpaid. Most investors (the people doing the lending) simply lose their money--that's why bonds aren't completely risk-free. Countries have leveraged debt since the concept was invented, so it's no surprise that countries themselves also go bankrupt.

Here are some of the historical national bankruptcies I've found:

Spain's bankruptcies of 1557, 1560, 1576, and 1596. Yes, four national bankruptcies in 40 years. This is while Spain was plundering the New World and raking in huge amounts of gold and silver bullion! In the 1557 bankruptcy King Phillip II simply refused to pay debts, and that ruined several large banking houses in Germany.
France's near-bankruptcy of 1789. France was likely only months away from defaulting on several expensive loans, but then revolution broke out. The poor state of the nation's finances has been called out as a major reason for the French Revolution (see the wiki link). After the revolution, the new leaders of France simply expropriated property as needed and executed unhelpful lenders--which I think counts as default.
Portugal's bankruptcies of 1892 and 1902, which, like today in Greece, caused widespread unrest and riots in Portugal.
Germany's bankruptcies of 1923 and 1945. The 1923 bankruptcy (and preceding hyperinflation) was especially chilling because it helped launch Hitler's career and the rise of the Nazi party. The 1923 bankruptcy came about due to complete currency collapse, leading the counry to default on foreign debt payments (debt payments which themselves were poorly-conceived reparations for World War I). The defaults of 1922 and 1923 led to occupation of its territories. The 1945 bankruptcy was due to the country's production problems after the decimation of its industries in World War II. Clearly, both bankruptcies caused widespread pain--and as I said, the 1923 bankruptcy was a major event that pushed the country psychologically towards World War II.
Russia's defaults of 1998. Russia defaulted on domestic debts, and massively devalued the ruble. Other debts were unilaterally restructured.
Argentina's bankruptcy of 2001. The impact on the economy (riots, bank runs, 25% unemployment) was severe. After years of deficit spending, corruption, and poor monetary policy, Argentina was forced to default on over $120 Billion (US Dollars) and massively devalued its currency.
Iceland's near-bankruptcy of 2008. This wasn't a "true" bankruptcy since Iceland didn't actually default on any loan payments. But that is only because they took a massive loan from the International Monetary Fund, and instituted harsh austerity measures. Their GDP is expected to shrink by around 10% (maybe more), unemployment has nearly tripled, and their currency has collapsed. Furthermore, many households have their debt indexed or denominated in foreign currencies. So the collapse of their currency has made things much worse for them. [this data is from the wikipedia article]

Printing money can be hard to clean up.
Image courtesy of Timur lenk (wiki)

On top of the human misery at the time, after the bankruptcy the countries found themselves unable to borrow at favorable rates. In general, this gives governments less flexibility and is (I think) a security risk--a lack of funds could be exploited by other countries for economic or even territorial gains. Certainly Greece will be hard-pressed to borrow more money until it demonstrates to the world that it can maintain fiscal responsibility for several years.

What I find most scary is that these defaults (with corresponding catastrophic impact to the nation involved) were usually not well foreseen ahead of time. That is, there were many people who recognized that the fiscal and/or monetary health and behavior was poor, but default and bankruptcy were usually a bit of a surprise to everyone.

The "surprise" nature of national bankruptcies is either due to fraud and misinformation at the highest levels (such as France's 1789 financial problems), or more commonly due to the fluctuating nature of national income. A country may think it can pay back its debt in 10 years, but then a war, famine, or recession can suddenly decimate cash flow to the point where a country realizes it is only months or weeks away from default.

Once you get to that point, you're toast. Anyone with money to lend won't go near you, and anyone who already lent you money is now freaked out and wants their money back. That's the nightmare scenario that Greece is facing now.

In the past, many countries have simply printed more money to solve the problem. Printing money is effectively a country-wide tax: as the currency devalues, all the money that you have becomes worth slightly less, and the value that you lost is now transferred to what was just printed. Taken to extremes, this corrodes trust in the currency to the point that it accelerates towards zero worth. But in some cases, careful inflation (printing money) allows the government to tax everyone enough to pay off debts.

However, printing money doesn't always work. If a large amount of your debt is foreign-denominated, devaluing your currency will make it even harder to pay off foreign creditors. That's what happened to King Philip (Spain) and the Weimar Republic (Germany) above.

Europe may just have to print Euros to bail out Greece. Basically, all of Europe will be taxed to save Greece. Personally, I think a solution like that is best: it reinforces what it means to be a European state. It is what we (United States) might do if we had to bail out one of our states, along with other measures.

Will any of this happen to the United States? That depends on if we can reign in spending, and how much patience our creditors will have. Personally, I see risks for both.

First of all, we haven't been able to stop overspending, and the problem with just get worse in the next few years as we won't be able to pay for Medicare or Social Security. Politicians are unable to fix either of those programs because it would be political suicide to even suggest changes. This isn't our politicians' fault: voters in the US recognize that we have fiscal problems here, but nobody is willing to accept cuts in their (future) benefits--even though cuts are mathematically inevitable. This is the same reason we see people rioting against austerity in Greece even though it is clear their government has no money.

Secondly, foreign investors are starting to see credible alternatives to the US Dollar. Both the Euro and, in a few years, the Yuan, will be good options for countries to hold foreign reserves. There are already proposals for just this sort of model. Once there are credible alternatives to the US Dollar, foreign investors won't put up with large deficit spending in the United States, and any risks (such as Medicare/Social Security insolvency) will result in even higher interest rates we'll have to pay to borrow money.

My predictions?

The European Union will save Greece. That seems most prudent from a stability level, and is also a painful but deep reminder of what it means to be a true European State--the Union will help (at a price).
Foreign creditors will continue to look for alternatives to the US Dollar. We'll see increasing interest rates as we borrow more money to pay for our deficits. This might lead to better fiscal discipline on our part, but I am a bit worried that we'll keep overspending anyway.

The result? Greece won't go bankrupt, although it will be painful for them over the next several years. And the US will face a high risk of bankruptcy in 5-10 years when creditors suddenly decide to stop lending. At that point we ourselves will be dangerously vulnerable to recessions or other events that reduce national tax revenues.

Comments

Related:
  > economics <
  predictions

Unrelated:
  books
  energy
  environment
  geopolitics
  lists
  mathematics
  science

Fri May 7 22:44:43 2010
Tree-Hugger Me
I'm a die-hard environmentalist in spite of my SUV.

This environmentally-conscious SUV also has a snorkel.
Image courtesy of Dazzuko (wiki)

Today I celebrated 6 weeks of commuting to and from work without driving!

This is all because I recently moved (see The Dream Tour), and I can bus to work and walk to almost everywhere I need to shop. I've been mostly commuting by public transit since December, but in March my parking pass ran out so I've been commuting 100% car-free since then. My gasoline consumption has dropped by around 50% or more compared to 2009, even though I often drive into the mountains on the weekends.

However, I still drive a large black SUV that gets really crappy gas mileage. So I can't really call myself an environmentalist, can I?

Well, actually I can and I do.

I was inspired by this story, which pointed out that most people think about environmentally-friendly driving entirely wrong. Most people think that we can help the environment by buying cars with better gas mileage. But as the article noted:

Science shows that cutting miles traveled by personal automobile is far more effective at reducing carbon than improving gas mileage.

So by moving and driving far less, I've actually reduced my carbon footprint much more than had I stayed where I was and bought a Prius.

Don't get me wrong, eventually I'll get a greener car. But it won't be a Prius. It will be an SUV that has cleaner emissions. I need a truck with clearance, room for cargo and gear, and four wheel drive.

That's another thing many people (including proclaimed environmentalists) get wrong, by the way. When it comes to the environment, gas mileage isn't important: emissions are important. The two are related, but they don't have to be. Car and truck manufacturers could be held to much stricter emissions than they are now. Paradoxically, better catalytic converters could slightly reduce gas mileage, but that would be overall worth it.

So what is the responsible, green future for the planet? It won't be suburbia with hybrids. It will be people living much closer to where they work and shop, driving far less, in cars that have about the same gas mileage as now, but with lower emissions. That's going to be a big demographic shift, but it will be better for the atmosphere, and will also be forced by rising gasoline prices.

Comments

Related:
  > economics <
  science
  environment
  predictions

Unrelated:
  books
  energy
  geopolitics
  lists
  mathematics

Tue Apr 6 22:25:15 2010
Gene Patents
A surprising verdict that could change everything.

No longer intellectual property?
Image courtesy of 84user (wiki)

What with the passage of the healthcare bill, the recent strategic armaments treaty, and earthquakes, an important story was mostly buried this week. The story, which is causing an uproar among biologists, is that the ACLU has just won a lawsuit which invalidates several gene patents. This article has a great overview of how the case unfolded.

This is big news. Why?

On the one hand, many people are worried that by blocking patents of human genes, companies and institutes will be unwilling to investigate genetically-targeted (or inspired) drugs. For instance, the Northwestern University report quoted above includes a quote from one lawyer:

You won't have disclosure to move onto the next step in biology

that is, because patents won't be filed, companies will keep genetic sequences private.

However, that same article quotes other practicing scientists as saying

There could be an increase in the amount of research done to attempt to find cures for disease.

and also notes independently that

Myriad Genetics could find other labs rivaling it and might be forced to lower the cost for the BRCA test.

[Myriad Genetics was the defendant in the lawsuit, and their BRCA breast cancer test relied in part on patents on the human BRCA1 and BRCA2 genes.]

I'm with the scientists on this one. Allowing patents of standard human gene sequences is dumb and contrary to the spirit of patents. It was a mistake to have allowed it in the first place, and the ACLU was right to challenge it.

Is this the end of patents for biotech? No. Even the scientists who supported the lawsuit noted that

The company spent significant time and money figuring out the structure of the gene and how to test for it, and thus are able to charge what they want to for the test.

In short, companies can patent anything they invent that is original, but can't patent Mother Nature.

It is early days still! The result will almost certainly be appealed. But I am hoping that higher courts will uphold the verdict. If so, I think we'll see even more genetic information publicly available, which should speed cures and lower costs for everyone.

Comments

Related:
  > economics <
  science

Unrelated:
  books
  energy
  environment
  geopolitics
  lists
  mathematics
  predictions

Links: