Growing up

The Inconvenient Truth about Sovereign Debt

by DETLEV SCHLICHTER

The efforts of our political leaders to socialize the fallout from the financial crisis by means of the balance sheets of the government and the central bank, and to thereby sustain an illusion of normalcy, have guaranteed that the financial crisis is now morphing into a sovereign debt crisis – a process that is unfolding at different speeds globally but that in many places is well advanced already. On a long enough time line, everywhere is Greece.

Crises clarify things. When the cash runs out and the chimera of harmony and “shared ideals” can no longer be sustained with borrowed or printed money, the hard questions get asked – and clear and blunt answers are finally given. No more time for fuzzy logic.

Who Owes Government Debt?

Who owes government debt? Who do the lenders to governments ultimately hold a claim against? The answer is not as obvious as it is in the case of loans to private entities, such as individuals or corporations.

In the case of Greece, for example, many will consider the answer to this question obvious: The Greek “people” have an obligation to repay the loans that banks and bond investors have extended to the government of the Greek “people”. After all, the government represent “the people” and have thus borrowed in the name of “the people”. So “the people” of Greece have a collective obligation to pay.

This is nonsense. It is unjust and economically absurd. Also, it is simply not going to happen. Forget about it. Not only in Greece – forget about it almost everywhere. Once the debt load has reached a certain level the “people” won’t pay – and rightly so.

The loan from a banker or bond investor to a government is a contract, and many people will assert that contracts have to be honoured for the market economy to work. But most Greeks never contracted for this debt, their government officials did. The loan is between a lender (bank or bond investor) and the government – a political entity. That entity has seriously overspent and is now going broke.

I maintain that the vast majority of people do not consider the debt of their government to be the equivalent of their own personal debt, nor do they feel obligated morally to assume responsibility for any action that government officials undertake or any contract that they sign. This position is sensible. To have any real sense of personal responsibility one needs to have control over affairs. In a democratic nation state, no single voter has sufficient control over the borrowing and spending activities of the government, and it would thus be absurd to assume the citizen will readily forfeit a considerable part of his or her future income or property to honour debts incurred by those who are running the government.

The whole notion of democratic “representation” has been obscured by constant propaganda trying to tell us that the government qua democratically elected government represents “the people”, that it looks after the “national interest” (which is a convenient political fiction) and “society as a whole”. This is evidently not the case. The government is not a true representative of anybody.

If the government officials were my representatives – like, for example, the lawyer and tax account who I hire to work for me, or the shop manager or other employees who work in my business, and for whose actions I do in fact take considerable responsibility – I could direct their activities, and most importantly, I could release them from their duties at any moment. In a democracy, I get a chance to kick out my “representatives” only every four or five years even if I tire of their “representation” much earlier, or more precisely, I get a chance every four or five years to cast an individual vote of infinitesimally small importance in a process that may replace one group of politicians with another group of politicians. Whatever my “representatives” do in these four or five years, I have to take the consequences – and live with these consequences for years and decades. If the presently ruling group of politicians decide to bail out the entire banking industry – all with my best interests at heart, of course – I have to foot the bill.

So, a secretly elected official, who I may or may not have voted for, whose supporters largely remain anonymous to me (elections are secret – which further weakens accountability!), whose actions I cannot direct, and who I cannot relieve of his duties for a number of years, can sign loan contracts which will place a considerable burden on my future income and my property.

Not likely.

It gets even more absurd. While my children do not have to pay for my debt – debt, for which their father signed personally – and can thus control their financial future without being burdened by my financial extravagance, they will be on the hook for servicing and repaying the debt of governments that accumulated that debt while they were not yet allowed to vote or were not even born yet – and that not even their father ever voted for.

If this represents the currently accepted notion of what a government is rightfully allowed to do, it is clear that then the notion of private property has no meaning in our society. In such a system there can be no private property. If the government can tax my income and property and engage in loan contracts that create an everlasting and potentially unlimited claim on my future income and future property – then the phrase “private property” is a vacuous term.

The German anarchist philosopher, Max Stirner, saw this very clearly already 166 years ago when he wrote in his “Der Einzige und sein Eigentum” (“The Ego and Its Own”) that if there was a state, all property was owned by it. The individual can just borrow it for a fee – taxes. Or, as Doug Casey put it: Try not paying your real estate taxes for a year or two, and you find out who really owns your house.

Such clear thinking is sadly the exception today when most people happily state that we need a state to protect private property. I would argue that today in all advanced democracies the state is almost certainly the largest threat to your property and future market income.

Private Debt versus Public Debt

Every loan is extended in the hope that it will get repaid out of future income. Loans to individuals and to corporations are therefore strictly limited by the assumed future earning power of the borrower. This earning power is by definition highly uncertain. Private individuals and corporations have no choice but to generate their income in the market place. This means, they can only generate income if they provide a service or help produce something that their fellow men and women voluntarily spend their money on, which is an inherently uncertain process given constantly changing consumer preferences, constantly changing technology and a constantly changing competitive landscape.

Because of this, lenders will usually also demand collateral for their borrowing when lending to individuals and corporations. Despite all these precautions, it is in the very nature of things that the loan is still risky. Future income and the future market value of the collateral must remain uncertain.

The state is under no obligation to generate market income. Indeed, it is the monopolist of compulsion and coercion within its territory, and thus the only entity that can legally obtain income by confiscating resources under the threat of violence.

This privilege makes lending to the state so appealing to banks and bond investors: you do not become a participant in a capitalist enterprise and are subject to the whims of the consumer, but instead you participate in the privilege of taxation. You get paid out of market income without having helped create market income. You get a share of what the state takes from those who did take financial risk and who happened to come out ahead. You can safely sit back, relax, and let the capitalist chips fall where they may – you just join the state in taking from the winners. Naturally, no collateral is required when lending to the state!

As a lender to the government you don’t have to study business plans and worry about what the government does with the money you give to them. The government’s ability to repay is entirely unconnected to how the government spends the loaned funds. “Spend” is indeed the appropriate phrase here, although many modern politicians have now adopted the practice of calling every government expenditure “investment”, so that it seems the electorate does ultimately get back more than it put in. Truth is that government spending is predominantly consumption – the funds get consumed in the present period, no lasting value is created.

When bankers and fund managers invest in government debt they channel savings back into consumption. These are savings that could have gone to the private sector where they would have helped build or maintain a productive capital stock that generates wealth in the future.

Government borrowing and the accumulation of sovereign debt are economically and socially destructive. Loans to the government are not on a par with private loan agreements in a true capitalist system – legally, contractually, ethically and economically they are something entirely different. They are agreements between two parties that are ultimately based on the persistent expropriation of property from a third party. Those who demand to have their outsized loans to the government repaid and those who demand that the government maintains the present level of public services and state handouts, essentially demand that the expropriation of the productive part of the community – the net taxpayers – not only continues, but that it is further expanded.

In the case of Greece, efforts are being made to avoid default or at least to contain the extent of the default. The aim is not to protect the productive part of the Greek population – Greece’s producers, investors and entrepreneurs and their property – but to save the banks and pension funds that lent – stupidly and lazily – to the Greek government, and most of which are located in the big EMU-states (particularly Germany and France). That it is done to “save the Euro” is nonsense, as I explained here.

To this end, Greece is put through a process of spending cuts and additional taxes and stricter tax enforcement. The goal is supposedly to allow the Greek government to return to the debt markets in the not too distant future so that – the government can borrow again! My advice to the Greeks would be, be careful what you wish for. A government that cannot borrow is the better option for long-term wealth creation and prosperity.

Out-of-control public spending is not confined to Greece. The sovereign debt crisis will spread. When bigger states get embroiled in it the powers that be will switch the printing presses into high gear. This process, too, has already commenced. The sovereign debt crisis, which originated from the financial crisis, will then morph into a fiat money crisis. Ironically, the supposedly safest assets – cash and government bonds – could end up being the most dangerous.