What MMTers Won’t Tell You About Local Currency Debt Default

It happens all the time

A country that issues its own currency cannot default on its debts. Wrong. Local currency debt issuance does not preclude the possibility of default. To see why, it is first necessary to appreciate that default comes in many forms. Many people think of default as a discrete credit event, where a borrower fails to repay principal or interest on a loan or a bond, triggering provisions that define a default for the underlying debt security. But that is a legal, not an economic, conception of default.

Default comes in many forms, not just explicit credit events. High and unpredictable inflation is a form of implicit debt default. Governments can enter into agreements with creditors for debt forgiveness or swapping new debt for old that may constitute partial default through a haircut on creditors. Governments can engineer debt for equity swaps, impose retrospective taxes on debt service payments or replace existing currency with new currency that effectively confiscates the public’s holdings of cash (a government liability, as MMTers like to remind us). Governments are endlessly creative in thinking of ways to confiscate wealth and appropriate real resources without having to pay for them.

A country that issues and borrows in its own currency may be better placed to avoid explicit default, but that does not preclude implicit default. According to the BoC-BoE Sovereign Default Database, which defines default events based on the preceding criteria, there have been 32 local currency sovereign debt defaults since 1960. Over the last decade, between four and eight sovereigns have defaulted on foreign currency bonds each year and between two and four on local currency debt. Moreover, as David Beers and his co-author warned in 2019 (pre-pandemic), ‘defaults on local currency debt could become as common as defaults on foreign currency bonds in future episodes of sovereign debt distress’ as government debt burdens grow.

It is also worth noting that the United States explicitly defaulted on the gold clause obligations in US Treasuries in 1933. As the dissenting judges wrote in the subsequent Supreme Court case:

“The enactments here challenged will bring about the confiscation of property rights and repudiation of national obligations. Congress really has inaugurated a plan primarily designed to destroy private obligations, repudiate national debts, and drive into the Treasury all gold within the country in exchange for inconvertible promises to pay, of much less value.”

The then gold standard offered little protection against a government determined to abandon it.

By the way, in case you were wondering whether short USD/long gold was a crowded trade:


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