Adonis Diaries

History of Sovereign Debts to “stupid citizens”: 12 Lessons made easy

Posted on: November 20, 2010

I decided to relegate the introduction last. Why?  I have read many articles on the critical problem of Sovereign Debts and what did I discover?  They are basically series of data, abridged definition of convoluted terms, and then nothing.  Without any serious analysis, who cares to consider conclusions that are politically oriented but inconsequential for learning anything?

State public debts may be contracted through external creditors (government funds, institutions, or private financiers), internal resources, and hidden debts such as social security funds…

There are 9 technical ways to resolving or camouflaging excessive sovereign public debts that State governments have invented through centuries of steady accumulation of debts:

Increasing taxes, direct, indirect, and hidden taxes that most citizens are not aware that they are actual taxes.

Decreasing expenditure in the budget and allocating the savings to paying interest on debts.

Increasing production and facilitating internal trades to increasing economic growth, thus, increasing fiscal revenues.

Decreasing the interest rates on contracted debts through financial transparency and political stability.

Increasing consumer prices by forcing inflation and a fictitious decrease of the debt rate compared to GNP.

Creating wars on the “enemy” creditors to defaulting on external debts (principal and interest portions).

Refinancing the debts by decreasing the interest rate or lengthening the due dates:  Creditors are willing to be paid something on regular basis than submitting to lengthy litigation procedures with the World Commerce and Trade organization.

Simply “defaulting” and letting the chips fall where they please (the most frequently adopted decision since the Middle Ages).  In the last two centuries, 320 cases of States’ outright defaults have been registered with frequent consequences of wars, swapping of colonies, and mandated power over military weaker nations.

What are the signs that a State is planning to default?

One: The newer elected government immediately demands refinancing the debts and renegotiating the terms in amount, interest rate, and timetable of payments.

Two:  Banking institutions threaten to declaring bankrupcy; meaning, the banks start to cut down on loans in amount and in numbers; thus, slowing down internal trade and the creation of small new enterprises.

Three:  Foreign creditors stop lending for many reasons.

Four: Financial institutions actually declaring bankrupcy and setting off a financial crisis so that government reacts promptly and comes to the rescue by infusing massive liquidity of the hardworking “citizens’ savings”

Why government generally goes for the policy of accelerated inflation in order to resolving sovereign debts?  First, consumer prices are allowed to increase by increasing tariff barriers for cheaper imports, encouraging monopolistic mergers, increased interest rates on loans, and slowing down internal production.  Inflation diminishes export competitiveness by an over valuation of the currency. Inflation is connected by dramatic rise in Real Estates prices called “bubble”.

What is the rational for creating inflation?

Debts not “indexed” on inflated prices (fiscal revenues are inflated since generated taxes seem to have increased and the nominal GNP shows increases) reduce the ratio of the debt to the GNP and the fiscal revenue, giving the illusion that effective amount of debt was reduced.  An annual inflation rate of 4%mechanically reduces the debt ration by 20% within 5 years.

What are the consequences of inflation?

If the salary is not indexed on the inflation rate then, the purchasing power of an individual diminishes and he has to borrow or find an additional job to making ends meet or be supported by his parents’ savings.  Usually, the State maintains all public salaries unchanged for several years in order to keep spending “under control”.

After WWII in 1945, the public debts of the England was 250% on its GNP, France 110% (which represented 10 fiscal years of revenues), and the USA was 100% of GNP.  These countries adopted the inflation plan for 30 consecutive years, factitiously reducing the ratio.  With steady economic growth, and since when prices of commodities increase they never come down, the average yearly income increased, but it was mostly hidden by the inflation factor.  For example, the Chinese worker with a salary less than $1,000 is saving half his earning so that the Chinese government finances the growing external debts of the “rich States” in order to maintaining the “standard of living” of their citizens that effectively reflects 30 years of inflation policy.  Fact is, one of the methods for sustaining inflation was creating credit cards with limits up to 50 times the actual earning of the individual!

When a State decides to default it might start by temporary suspending paying interest on due date if refinancing negotiation failed; coupons of lesser values are issued.  Property values drop 35% within 6 years; share values decline 55% within 3 years; unemployment increases 7% within 4 years, and production rate drop 9% within 2 years.  If you notice that many of these consequences are effectively taking place then, your State has defaulted but was not transparent in declaring the difficult situation.

In the medium-term after defaulting, a State witnesses internal unrests, higher in frequency and in violence; government creates a preemptive war on a neighboring State to absorb the surplus unemployed citizens in the lower middle class; and the State is reduced to a vassal position to more dominant creditor nations:  the defaulting State is unable to secure more loans for many years.

What kinds of financial mechanisms and financial tools (gimmicks) a powerful State resorts to amortizing the impact of a large sovereign debt?

One, the State may use special right of withdrawal from the International Monetary Fund (IMF), which is starting issuing worthless banknotes.  Two, the State may create special perpetual funds generated by particular taxes designed to repaying the debt (political exigencies always use special funds for missions not intended to it, under the pretext of extraordinary emergency events).  Three, the State may nationalize productive sectors in the industries and then issue bonds on public properties.  Four, the State may declare the land of the nation is public property and all private properties should be rented for a specific period.  Five, all the time, the State is just printing money with decreasing values as long as the sovereign debts is huge.

The financial clubs and institutions that the powerful nations used to recovering their assets were: One, the “Club of Paris” was established in 1956, constituted of all the creditor nations (the G7) and international institutions, to manage the public debts contracted by the third world countries.  As Germany and Japan accumulated surplusses in their economies they tended to convert their dollars to gold; Nixon decided in 1971 suspended the convertability of dollar to gold and starting the devaluation trend of the dollar.  That was the end for the fictitious “Gold Exchange Standard”.  Two, the “Club of London” was established in 1979 in order to gathering all the commercial banks creditors to poorer States.  Thus, debtors States had to first refinance or renegotiate their public debts with the Club of Paris so that the Club of London executes the details with the commercial banks. Three, the International Monetary Fund (IMF) began getting involved after 1983 when major emerging States suffered financial problems.

Invariably, States unable to generate enough fiscal revenues so that 50% of the budget are dedicated to paying interests on sovereign debts are in deep trouble.  Many developed Nations can sustain up to 300% of debt to GNP for several years, while developing countries crumble under 50% ratio, simply because the political system is unstable and unable to bring in at least 50% of the budget to cover paying interest on debts.

1 Response to "History of Sovereign Debts to “stupid citizens”: 12 Lessons made easy"

[…] Lessons made easy: Sovereign Debts to “stupid citizens” […]

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November 2010

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