A Jubilee Not to Celebrate: Debt Forgiveness

(Evgen_Prozhyrko/Getty Images)
Stiffing creditors violates property rights, spikes interest rates, and destabilizes markets.

NRPLUS MEMBER ARTICLE W ith U.S. debt at record levels, calls are being heard for a debt jubilee, in which all or part of the country’s mountain of debt would be written off, to the great relief of debtors and the despair and probable bankruptcy of creditors. Not all bad ideas are new, however. Debt jubilees have been around for a long, long time, since, in all probability, Bronze Age Sumer, a civilization located in the south of modern-day Iraq, in around 2300 b.c. Sumerian lending was carried out primarily by temples, which were not only wealthy but were able to add some spiritual menace to more-routine debt-collection techniques. New rulers often proclaimed debt jubilees on ascending the throne or on the completion of a successful war. Given the relatively short lifespan of Sumerians, these debt jubilees probably occurred at least every 20 years.

Sadly, although it was a brave start (Sumer was probably the first major civilization), Sumer was not known for its high standard of living, and debt jubilees were unlikely to have helped.

According to Sidney Homer’s History of Interest Rates, there was very little long-term debt in Sumer and interest rates were around 33 percent. The annual loan Sumerian farmers might take in order to sow their crops had a low chance of being forgiven but came at a high cost.

After their Sumerian beginnings, debt jubilees are mentioned in the Babylonian Code of Hammurabi, around 500 years later. They were recommended in Leviticus and practiced from time to time in medieval Europe.

There is a modern practitioner of what are effectively debt jubilees: Argentina. Every ten years or so since 1929, Argentina has defaulted on its international debt, with a massive struggle between borrowers and lenders leading to a partial debt write-off, after which Argentina is readmitted to the international markets. The most recent readmission was 2016, after the election of Mauricio Macri as president. His government celebrated his country’s newfound respectability by borrowing some $70 billion over the next few years, nearly $50 billion of which came from the suddenly generous International Monetary Fund. Then, last fall, Macri lost his bid for reelection and the new leftist government has now effectively defaulted again, demanding terms from Argentina’s lenders under which the country would pay them no interest or principal for three years — a timetable that takes the government safely past the next elections.

If debt jubilees did any good, Argentina would be rich today. It was indeed rich in 1929, before it started defaulting regularly. (It had defaulted a few times in the 19th century, but lenders then were tougher, so it did not gain much by it.) Since then, Argentina has, according to the IMF, sunk from being one of the world’s five richest economies to the 69th-richest today.

There’s no keeping a bad idea down, however, and, as mentioned above, calls for an American debt jubilee are growing. To those recommending it, the advantage of bringing some Bronze Age financial thinking to America would be the reset it delivered. Depending on how far it went, an American debt jubilee could be used to de-leverage the U.S. government. Certain kinds of debt could be written off, but not others. For example during his recent presidential campaign, Senator Bernie Sanders recommended forgiving all or most of the nation’s $1.4 trillion in student debt. And at least in principle, it might be possible to repay some creditors but not others — we might stiff the People’s Bank of China (holder of about $1.1 trillion of U.S. Treasuries) while repaying little old ladies with savings bonds.

Tempting (to some) as that might sound, the damage caused by such an approach cannot be wished away. And the essence of that damage lies in the violation of property rights that a jubilee entails. Without secure property rights in the loan they are extending, investors cannot put much reliance in the return that it is supposed to deliver. To make up for the uncertainty, they will demand a substantial premium. In 18th-century Britain, when property rights were taken more seriously than they are today, debt jubilees were impossible and a defaulting debtor could expect a tough time, including, possibly,  imprisonment. In consequence, interest rates in Georgian Britain were far lower than in Sumer, around 5 to 8 percent for secured farm borrowers, and no more than 3 to 5 percent for the government.

While a system with regular debt jubilees might work for a society content to operate at a relatively low level of economic development, such a system would be a disaster for a society that was hoping to aim higher. The moral hazard and elevated risk that would come with such a system would keep interest rates far higher than they otherwise would be. The property rights of lenders are continually trashed, taking trust with them. In response, interest rates rise to Sumerian-style levels, well into double digits, and then they tend to stay there. After all, why would anyone lend money if he knows there’s a chance of the debt being annulled by government fiat? With interest rates so high, economic activity is hobbled, as Argentina has found during its frequent periods of default. And, as we see in Argentina, the cumulative effect can be devastating.

A full debt jubilee would thus give short-term relief to debtors but cause the bankruptcy of an immense range of creditors, not only banks but also insurance companies, pension funds, and the like, while reducing stock prices to a level commensurate with the scarcity of debt finance and the new higher level of interest rates. As for defaulting only to China, that might, quite understandably, be taken as something akin to an act of war by Beijing, a prospect that would make the bond markets very unstable, and not only because of fears about China’s response. How could any other bond buyers trust that the U.S. Treasury might not suddenly take a dislike to them?

While debt jubilees are a bad idea, there is one useful way that the U.S. government could take advantage of the current period of artificially and excessively low interest rates, and that is to restructure its debt. The U.S. government currently issues no debt with a maturity of more than 30 years, and most of its debt is much shorter than that. Consequently, when interest rates return to “normal” levels, the interest cost of public debt will quickly soar as maturing debt is refinanced. The solution, in current markets where interest rates are artificially low and the market very receptive, is to issue debt of a longer maturity, ideally reverting to Britain’s main financing method between 1751 and 1914 (although there were some additional issues in the interwar years): “perpetual” bonds known as Consols.

As I write, the ten-year U.S. Treasury yields 0.69 percent, and the 30-year Treasury yields 1.42 percent. Perpetual Consols should yield a premium over 30-year bonds, but a modest one, less than would be demanded in the case of a 100-year bond, for example. (Consols are generally issued at a discount, offering the possibility of a capital gain if yields decline; this is not true for a 100-year bond issued at or near par.) Suppose a yield of 1.5 percent is necessary; this could be achieved by issuing a 1 percent Consol at a price of 66.7 percent, or by a 1.5 percent Consol at par. (Since there is no maturity, the yield on a Consol is simply the coupon divided by the issue price.)

By issuing Consols as described, the U.S. Treasury would be getting a much better deal than 18th- and 19th-century British governments, which paid a real rate of 3 percent or more on their money. In this case, with consumer price inflation currently 1.5 percent in the year to March 2020, the Treasury would be issuing perpetual debt with a real cost of zero — in other words, free money, with inflation reducing the value of the outstanding debt each year by as much as the interest paid. By issuing as much as possible of this debt while real interest rates are at current levels, the U.S. Treasury would greatly reduce the burden of U.S. public debt on future generations.

A debt jubilee is a bad idea; it violates property rights and would wreck the capital markets and cause interest rates to soar well into double digits. A major move by the U.S. Treasury toward Consols issuance, however, would have many of the effects of a debt jubilee and would be blessed by future generations for as long as U.S. Consols were outstanding — 264 years if they matched the British Consols, the last of which were not redeemed until 2015.

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