Why sovereign debt crisis

Because of the inelasticity of MR's supply, the increase in demand exerted by Germany in its national currency leads to its devaluation with respect to MR, which supports Keynes's claim about the additional cost of the payment of war reparations caused by the transfer problem.

Keynes was not able to convince his fellow economists, and his intuition remained somehow mysterious. Indeed, if devaluation was the necessary consequence of the payment of a country's net foreign purchases of commercial and financial goods of which the payment of war reparations is only a particular case , a great number of countries should actually suffer from a constant and massive devaluation of their national currencies, which is not the case.

What Keynes did not investigate was the possibility for the neutralization of the devaluating pressure by means of a foreign loan. Instead of purchasing on the foreign exchange market the foreign currency needed to pay for its net imports commercial and financial , the deficit country can finance them by borrowing abroad the required sum of MR. Yet, it is hardly necessary to note that, while it avoids the devaluation of the deficit country's national currency, the resort to a foreign loan does not avoid the implications of Keynes's transfer problem.

It is indeed clear that the deficit country can avoid the devaluation of its domestic currency only at the cost of incurring an external debt. This shows that Keynes's diagnosis of the transfer problem is but a first, important step towards that of an increasingly worrisome disorder: that of the external debt crisis. A privileged starting point is the balance-of-payments identity between global imports and global exports: where IM represents the sum total of a country's imports or purchases of commercial and financial assets, and EX stands for its total exports or sales of commercial and financial assets.

The founding principle of the balance-of-payment identity is that of double-entry bookkeeping. Each transaction entered in the accounts as a credit must have a corresponding debit and vice versa. Let us refer to the fact that — as Stern explicitly maintained, and Krugman and Obstfeld among others successively reiterated — each transaction must be recorded as a credit and a debit.

We immediately see that the required equality between total purchases and total sales is but a consequence of double-entry bookkeeping as applied to each transaction entering the balance-of-payments. It states that each country's foreign global purchases are always and necessarily equal to its foreign global sales or, in Schmitt's words, that countries too are subject to the law of the identity between each economic agent's sales and purchases see Schmitt, Let us consider the case of a country suffering from a positive sovereign debt.

According to the majority of economists and experts of international economics, such a situation arises when a country's expenditures exceed its sales, so that it has to incur a debt to finance its net imports through a foreign loan. Let us make it clear from the outset: the problem is macroeconomic and concerns the country as a whole, as the set of its residents.

A very simple numerical example will prove useful. Consider a country, A, whose global imports are equal to 11 MR for example, billions of US dollars , and whose global exports are of 10 MR, where MR stands for money of country R, the rest of the world. In order to finance its net imports of 1 MR, country A has to obtain a foreign loan of that amount from R. It seems therefore obvious to infer that country A incurs an external debt, and that its residents will have eventually to accept the austerity measures required to honour it.

Apparently, respect of the balance-of-payments identity entails the formation of A's sovereign debt, which leads to the unavoidable conclusion that country A has lived beyond its means. This is however to forget that, by imposing the equality between A's total imports and its total exports, the balance-of-payments identity is inconsistent and at odds with the formation of an external debt of the country itself.

In other words, once the identity is established, A's net imports are fully paid through equivalent exports, and no justification can be found for the existence of a positive sovereign debt. Let us analyse further our numerical example and verify what happens when A obtains a foreign loan from R.

According to the initial situation, R's imports of A's current output are only equal to 10 MR, while its R's exports of domestic current output are equal to 11 MR. The loan obtained from R has the effect of reducing to zero the difference, of 1 MR, between R's total exports and its total imports. Indeed, A will reimburse the loan, in a successive period, by giving up an equal amount of foreign currency earned through its exports of real goods.

Since the period in which R's loan is granted to A, country R acquires the ownership over part of A's future production, and brings its total imports to the level of its total exports, 11 MR. We claim that, having paid the totality of its imports in real terms through an export of its current production and one of its future output, country A should not incur any external debt to R. As a matter of fact, as implied by Keynes's intuition concerning the duplication of the cost of war reparations, country A's sovereign debt is the pathological result of a duplication due to the absence of a true system of international payments.

Analogously with Keynes's argument, country A's net imports are paid by A's residents and additionally by their country. This is so because, in the present non-system of international payments, the transfer to R of the real payment of A's net imports carried out by its residents can only take place at a cost: the monetary payment adds up to the real payment and forces country A to incur an external debt totally unjustified and unjustifiable.

Indeed, Schmitt proves that presently two foreign loans are required for the payment of A's net imports. One loan makes up for the real payment, whereas a second loan is necessary to carry out the monetary payment.

What has gone unnoticed so far is that a single loan cannot have as its object both a sum of real goods and a sum of foreign currency. Two equalities are crucial here: 1 The sum of real values exported commercial and financial must be equal to the sum of real values imported also commercial and financial ;.

The sum of monetary payments must be the same for A and R. Equality 1 is obtained through the export of a sum of A's future products; it results from the first loan of 1 MR granted to A by the rest of the world. Equality 2 calls for a new loan of 1 MR, which gives rise to A's sovereign debt. The second loan is macroeconomic , and provides country A with the amount of foreign currency MR it needs to make up for the difference between its expenditures and its receipts.

In order to finance both its future exports of real goods and its actual net imports, country A has to borrow abroad. Two loans of 1 MR each are required, of which only one is justified. The second loan is the consequence of the pathological system of international payments adopted so far, which does not provide countries with the international means of payment necessary to convey the payment, in real terms, of their net global imports.

The first loan is an ordinary one and, as such, is included in A's balance-of-payments. It is perfectly in line with the balance-of-payments identity and is thus perfectly justified.

In other words, the ordinary loan specifies a debt incurred by A's residents that does not in the least entail a positive, macroeconomic indebtedness of their country. On the contrary, the second loan is of a macroeconomic nature and, although incurred by country A's residents, defines a debt that rests on the country as a whole: a sovereign debt. When country A's residents borrow 1 MR, they obtain from R the financing of an equivalent part of their future output: the loan will be reimbursed in a successive period through a real export of A's economy.

This means that lenders of R become the owners of part of A's future production from the moment the loan is granted to A. In other words, economy A gives up immediately the ownership over part of its national output to be produced in the future, which is tantamount to saying that, through its loan, R finances part of A's future production. This is nothing other than the real payment of A's net imports. Yet, A's net purchases are still to be paid monetarily , because R's exporters have to be paid in MR.

Given that the object of the first loan obtained by A's economy is part of its future product and not a sum of MR, a second loan of the same value is necessary for A to pay its net imports. It is this second loan that gives rise to A's sovereign debt.

Finally, two loans of 1 MR value each are required to settle A's net foreign purchases whose value is merely equal to 1 MR. The second loan is totally unjustified and is the mark of the duplication arising today any time a country finances its net imports through a foreign loan. Let us shortly go back to the balance-of-payments identity. Today, it is thanks to R's first loan that the identity is complied with. Through this loan, R's total imports are increased from 10 MR to 11 MR, because its effect is to give R the ownership over part of A's future production.

This brings A's exports to the level of its imports, and defines the real payment or the payment in real goods of its initial net imports. At this point, the reader could remark that A has not yet reimbursed the loan obtained from R, which would justify the existence of a net debt of A to R.

This argument is not correct, because it misses the fact that the amount of foreign currency, equal to 1 MR, lent by R is still available in A. Having fully paid in real terms its net imports, A should indeed benefit from a positive inflow, of 1 MR, which would match its external debt. It follows that, in itself, the balance-of-payments identity is never the cause of any positive sovereign debt.

If things go wrong and countries incur sovereign debts it is because the present system of international payments is not in line with this identity: it forces indebted countries like A to use the foreign currencies obtained from R to pay additionally for their net imports. A's sovereign debt is precisely the result of the loss of the foreign currency that should have increased its official and private reserves.

The necessity of two foreign loans of 1 MR value each results very clearly from the fact that A must at the same time reimburse the lenders of R and pay R's exporters.

Since A will give up to R part of its future output, the foreign currencies obtained as a loan should be added to its international reserves of period p 0. This not being the case, A loses both part of its future production and an equal part of its current output. The first loss is due to the reimbursement of the loan obtained from R, the second loss is due to the foreign debt that A incurs since period p 0. A distinction between periods helps to understand the problem. Let us suppose that economy A reimburses the loan obtained in the first period, p 0 , in the following period, p 1 , and that A's net imports in p 1 are equal to the ones in p 0.

In order to reimburse R in period p 1 A must give up part of the foreign currencies it earns through its exports. However, A's total purchases in p 1 are of 11 MR, the difference between A's total expenditures and its net entries in foreign currency are therefore equal to 2 MR, twice the amount of its net imports. Let us consider the case of Greece. Everybody seems to agree that the huge amount of Greece's sovereign debt is the unavoidable result of it having lived beyond its possibilities and having benefited from free lunches at the expense of the rest of the world in general, of Germany and other European countries in particular.

Now, this would indeed be true only if Greece had never paid for its net imports, which is not the case. In reality, Greek residents have paid the totality of their imports, net imports included, in their own national money. Since Greek residents have lost part of their national income to cover for the real payment of their foreign purchases, there is no logical justification for the formation of the external debt of their own country.

In the same way as Germany should not have run an external debt on top of its national product lost in war reparations, Greece should not carry the burden of a sovereign debt that adds up to the loss of national income suffered by its domestic economy. Given the complexity of the argument and its relevance for the future of indebted countries, let us discuss further the double payment of net imports.

What must be made clear from the outset is that the pathology denounced by Schmitt , , Cencini , , and Cencini and Rossi characterizes the present non-system of international payments and occurs any time a net importing country pays for its net foreign purchases through a foreign loan. A first and superficial analysis seems to corroborate the wide-held belief that the external debt incurred by deficit countries is perfectly justified, because of the foreign loans required to finance their net imports of commercial and financial goods.

Only two possibilities are therefore conceivable: either 1 The domestic income spent by a net importing country's residents is earned by the country itself, or. As everyone can immediately verify, the net importing country its central bank, government, or Treasury is not credited with the domestic income spent by its residents. If it were, it could be maintained that the country's external indebtedness derived from the foreign loan that finances its net imports is balanced by a net inflow of domestic income.

This not being the case, it is compulsory to infer that net importing countries suffer at the same time from a loss of national income and an increase in their external debt. The previous conclusion might sound weird and a critical reader could point out that, if it were true that net importing countries lose part of their national income every time their residents pay for their net imports commercial and financial , deflation would have severely hampered their economies.

The presence of deflation would be there to confirm the existence of the double payment we are so painstakingly trying to prove. The fact that deficit countries do not suffer from such a decrease in their current national income is therefore the clear proof that these countries do not have to pay twice for their net imports, and that their sovereign debt is entirely justified.

Or is it? Indeed, it is beyond dispute that countries do not earn the amount paid by their residents. If, lost through the payment of A's net imports, the amount of domestic income spent by the country's residents in the payment of their net imports is still available in A, it is because A has somehow recovered it.

Now, what allows for the recovery of A's domestic income is the first loan obtained by A's economy from the rest of the world. In any case, the object of the first loan obtained from R is not an amount of MR, but rather an amount of MA that, by restoring the previous level of A's domestic income, allows for the financing of its future production.

Whatever explanation we choose eventually, it leads to the conclusion that another loan is required in order for A to be able to pay, in money terms, its net imports. Country A must carry out the payment of R's exporters in MR, which makes it compulsory for A to incur another debt in order to obtain the required amount of MR.

As previously observed, the reason of the pathological formation of sovereign debts lies in the lack of a true system of international payments allowing for the automatic and cost-free transfer of the payments carried out by the residents of different countries.

Such a system exists within any given country, so that the monetary payment is never added on top of the real payment. Banks provide the necessary vehicular money at no cost, and the structure of the banking system is such that it guarantees the vehicular use of bank money.

This is unfortunately not the case at the international level. Deficit countries must pay for the purchase of a means of payment money that a system of international payments should provide free of cost.

The real payment of net imports is perfectly justified, no one denies it, but it is highly unjust that, on top of losing part of its national product, a country has to get indebted in order to obtain a mere numerical means of payment.

It is no mystery that Spain is a heavily indebted country. Before analysing the situation of Spain starting from the official data published by the World Bank and the IMF, a few words are necessary to do away with an apparent contradiction between our claim that net importing countries, Spain included, pay twice their net imports, first in domestic income and, additionally, in MR, and the fact that Spain is a member of the euro-zone and so pays in euros for its net purchases from other member countries.

It is clear that if the euro were indeed a single currency, payments among euro-zone member countries would be of the same nature as the payments carried out by residents of different regions of the same country. If this were the case, no sovereign debt between euro-zone member countries could ever arise, because their residents would carry out all their payments using the same unit of account and the same system of final settlements.

Two observations lead, however, to a different and rather distressing conclusion. Both are factual and conceptual at the same time. As it happens within any national banking system, payments between clients of different banks require the intervention of the central bank acting as monetary and financial intermediary.

This implies both the emission of central bank money and the implementation of a real-time gross settlement mechanism founded on a system of multilateral clearing. Because of the lack of a common form provided by a process of catalysis managed by the ECB, national currencies of euro-member countries are doomed to remain heterogeneous: despite appearances to the contrary, the euro is not yet the single currency people assume it is.

Hence, Spain's residents carry out their international payments in Spanish euros , Italian residents carry them out in Italian euros , Greek residents in Greek euros , and so on.

It follows, that the general analysis introduced in the first part of this paper holds good for Spain not only with respect to its extra-European payments, but also for its external payments within the euro-zone. In order to carry out the statistical verification or refutation of any theoretical thesis one has first to establish the relevant statistical data and their reliability.

In our case, the relevant data concern the amount of Spain's external debt and of all those balance-of-payments entries that can justify it. As for Spain's debt, the best official data at our disposal are those of the gross external debt position and these can be found in The World Bank Open Data collection of time series data of the World Bank.

In Table 1 the reader can find the yearly data concerning Spain's gross external debt position from to The difference between the amount reached in and that of end of the year , shows the increase in debt Spain had to endure in the period under exam. Statistical data concerning Spain's external debt between and in millions of US dollars. As for the data liable to justify this increase, the most significant are those of Spain's current account CA deficit.

The ones entered into Table 1 are those collected by the IMF and show a persistent deficit throughout the period — and a surplus for the following three years. The sum of Spain's net current account deficits from and explains part of the increase in its external debt during the same period. Another pertinent data set concerns the variation in Spain's official reserves.

Yet, as the data of Spain's external debt are those of its gross external debt position and given the negative sign of Spain's current account, it is clear that the increase in its official reserves gives necessarily rise to an equal increase in its gross external debt.

The same is true for the other components of Spain's official reserves. Gold, for example, is an asset that the Spanish central bank can obtain only by purchasing it, a transaction that requires the expenditure of an equivalent amount of foreign currencies. Finally, the positive variation in Spain's official reserves, given by the difference between their amount in and in end of the year , has to be included in the data accounting for the increase in Spain's gross external debt position in the period — Greece's debt was, at one point, moved to junk status.

Countries receiving bailout funds were required to meet austerity measures designed to slow down the growth of public-sector debt as part of the loan agreements. Some of the contributing causes included the financial crisis of to , the Great Recession of to , the real estate market crisis, and property bubbles in several countries.

By the end of , the peripheral Eurozone member states of Greece, Spain, Ireland, Portugal, and Cyprus were unable to repay or refinance their government debt or bail out their beleaguered banks without the assistance of third-party financial institutions.

Also in , Greece revealed that its previous government had grossly underreported its budget deficit, signifying a violation of EU policy and spurring fears of a euro collapse via political and financial contagion. Seventeen Eurozone countries voted to create the EFSF in , specifically to address and assist with the crisis. The European sovereign debt crisis peaked between and With increasing fear of excessive sovereign debt , lenders demanded higher interest rates from Eurozone states in , with high debt and deficit levels making it harder for these countries to finance their budget deficits when they were faced with overall low economic growth.

Some affected countries raised taxes and slashed expenditures to combat the crisis, which contributed to social upset within their borders and a crisis of confidence in leadership, particularly in Greece. Several of these countries, including Greece, Portugal, and Ireland had their sovereign debt downgraded to junk status by international credit rating agencies during this crisis, worsening investor fears.

A report for the United States Congress stated the following:. In early , the developments were reflected in rising spreads on sovereign bond yields between the affected peripheral member states of Greece, Ireland, Portugal, Spain, and most notably, Germany. The Greek yield diverged with Greece needing Eurozone assistance by May Greece received several bailouts from the EU and IMF over the following years in exchange for the adoption of EU-mandated austerity measures to cut public spending and a significant increase in taxes.

The country's economic recession continued. These measures, along with the economic situation, caused social unrest. With divided political and fiscal leadership, Greece faced sovereign default in June The Greek citizens voted against a bailout and further EU austerity measures the following month.

The withdrawal of a nation from the EMU would have been unprecedented, and if Greece had returned to using the Drachma, the speculated effects on its economy ranged from total economic collapse to a surprise recovery. In the end, Greece remained part of the EMU and began to slowly show signs of recovery in subsequent years.

This vote fueled Eurosceptics across the continent, and speculation soared that other countries would leave the EU. It's a common perception that this movement grew during the debt crisis, and campaigns have described the EU as a "sinking ship.

Investors fled to safety, pushing several government yields to a negative value, and the British pound was at its lowest against the dollar since A combination of market volatility triggered by Brexit, questionable performance of politicians, and a poorly managed financial system worsened the situation for Italian banks in mid A full collapse of the Italian banks is arguably a bigger risk to the European economy than a Greek, Spanish, or Portuguese collapse because Italy's economy is much larger.

Italy has repeatedly asked for help from the EU, but the EU recently introduced " bail-in " rules that prohibit countries from bailing out financial institutions with taxpayer money without investors taking the first loss. Germany has been clear that the EU will not bend these rules for Italy. Ireland followed Greece in requiring a bailout in November , with Portugal following in May Italy and Spain were also vulnerable.

Spain and Cyprus required official assistance in June The situation in Ireland, Portugal, and Spain had improved by , due to various fiscal reforms, domestic austerity measures, and other unique economic factors.

However, the road to full economic recovery is anticipated to be a long one with an emerging banking crisis in Italy, instabilities that Brexit may trigger, and the economic impact of the COVID outbreak as possible difficulties to overcome. But these measures lowered economic growth and tax revenues. As interest rates continued to rise, Greece warned in that it might be forced to default on its debt payments.

But they demanded further budget cuts in return. That created a downward spiral. It was after bondholders, concerned about losing all their investment, accepted 25 cents on the dollar. Greece landed in a depression-style recession, with the unemployment rate peaking at The Greek debt crisis was a huge international problem because it threatened the economic stability of the European Union.

The Greek debt crisis soon spread to the rest of the eurozone, since many European banks had invested in Greek businesses and sovereign debt. Other countries, including Ireland, Portugal, and Italy, had also overspent, taking advantage of low interest rates as eurozone members. The financial crisis hit these countries particularly hard. As a result, they needed bailouts to keep from defaulting on their sovereign debt. Spain was a little different. The government had been fiscally responsible, but the financial crisis severely impacted its banks.

They had heavily invested in the country's real estate bubble. When prices collapsed, these banks struggled to stay afloat. Spain's federal government bailed them out to keep them functioning. Over time, Spain itself began having trouble refinancing its debt. It eventually turned to the EU for help. That stressed the structure of the EU itself. Germany and the other leaders struggled to agree on how to resolve the crisis. Germany wanted to enforce austerity, in the belief it would strengthen the weaker EU countries as it had Eastern Germany.

But, these same austerity measures made it more difficult for the countries to grow enough to repay the debt, creating a vicious cycle. In fact, much of the eurozone went into recession as a result. The Eurozone Crisis was a global economic threat in Many people have warned that the United States will wind up like Greece, unable to pay its bills.

But that's not likely to happen for three reasons:. In , the United States came close to defaulting on its debt due to political reasons. The tea party branch of the Republican Party refused to raise the debt ceiling or fund the government unless Obamacare was defunded. It led to a day government shutdown until pressure increased on Republicans to return to the budget process, raise the debt ceiling, and fund the government.

The day the shutdown ended, the U. The U. Democrats, who favored tax increases on the wealthy, and Republicans, who favored spending cuts, fought over ways to curb the debt. In April , Congress delayed approval of the Fiscal Year budget to force spending cuts. That almost shut down the government in April. In July, Congress stalled on raising the debt ceiling, again to force spending cuts. Congress waited until after the results of the Presidential Campaign to work on resolving their differences.

The sequestration, combined with tax hikes, created a fiscal cliff that threatened to trigger a recession in Uncertainty over the outcome of these negotiations kept businesses from investing and reduced economic growth. Even though there was no real danger of the U.