On Russia, Sovereign Debt Defaults and Fiat Currency

I have said on a number of occasions that a sovereign nation that issues debt in its own fiat currency cannot default involuntarily. The case most people point to as a counterfactual is Russia in 1998. I mentioned Russia in a recent post:

Countries that have gone bust, Russia, Mexico, and Argentina were borrowing in foreign currency because of interest rate differentials. No sovereign nation which prints and issues debt in its own fiat currency can ever involuntarily be made insolvent.

I was on a trading desk that was dealing in synthetic GKOs before Russia defaulted in 1998, so I remember the incident quite clearly. Russia’s was not an involuntary default by a country which issues debt in its own fiat currency. Russia was a perfect example of a voluntary default due to huge foreign currency debt and foreign exchange reserve losses (see Wikipedia for a pretty accurate and thorough account on the events of the 1998 Russian financial crisis).

Marshall Auerback summed it up well in an email to me as we discussed this case in view of his post refuting chatter about Japan defaulting. Note the bolded words.

Russia didn’t have to default. As a point of logic, the concept of ability to pay being inherently revenue constrained is not applicable to the issuer of a currency. Any such constraints are necessarily self-imposed (including various ‘no overdraft’ legislation in some countries for the Treasury at the Central Bank). The issuer can always make payment of its currency by crediting the appropriate account or by issuing actual paper currency if demanded by the counter party.

An extreme example is Russia in August 1998. The rouble was convertible into $US at the Russian Central Bank at the rate of 6.45 roubles per $US. The Russian government, desirous of maintaining this fixed exchange rate policy, was limited in its willingness to pay by its holdings of $US reserves, since even at very high interest rates holders of roubles desired to exchange them for $US at the Russian Central Bank. Facing declining $US reserves, and unable to obtain additional reserves in international markets, convertibility was suspended around mid August, and the Russian Central Bank has no choice but to allow the rouble to float.

All throughout this process, the Russian Government had the ability to pay in roubles. However, due to its choice of fixing the exchange rate at level above ‘market levels’ it was not, in mid August, willing to make payments in roubles. In fact, even after floating the rouble, when payment could have been made without losing reserves, the Russian Government, which included the Treasury and Central Bank, continued to be unwilling to make payments in roubles when due, both domestically and internationally. It defaulted on rouble payment by choice, as it always possessed the ability to pay simply by crediting the appropriate accounts with roubles at the Central Bank.

Why Russia made this choice is the subject of much debate. However, there is no debate over the fact that Russia had the ability to meet its notional rouble obligations but was unwilling to pay and instead chose to default.

Russia defaulted voluntarily, an event which the geniuses at Long-Term Capital Management failed to model correctly. Moreover, the immediate stress on Russia was not the rouble-denominated debt but the mountain of foreign currency obligations via an unrealistic currency peg which were draining reserves. Similar events unfolded in Argentina a few years later as their currency board crumbled and the Peso was devalued by three-quarters.

Again, the point is that a government can always make good on its own fiat currency obligations if it chooses to do so. The real question is why a country might voluntarily default on its own currency debt or involuntarily on foreign currency debt. The answer usually has to do with taxes. In Argentina and Russia, the government was unable to prove that its taxation policies were benefitting its citizens, creating rampant tax evasion, especially in the monied classes. Capital flight took form as many dodged taxes. Capital flight eventually turns into currency revulsion which creates the pre-conditions for depression, as Latvia, Estonia and Lithuania learned most recently.

The relationship these examples from the Baltics, Argentina and Russia have with Japan and the United States is taxes. When taxes seem unfair or excessive, the citizens evade taxes and eventually revolt; you end up with a situation like Russia circa 1998, Argentina circa 2002 or Zimbabwe circa 2007.

Comments

[notsosmart:]

this will happen over & over.

Nov 04 04:34 PM

[Alan Young:]

Russia in the 1990's, after the collapse of the Soviet government, was complete anarchy, with default control falling to a cabal of kleptocrats. The usual cast of international financial and diplomatic networks apparently had no influence; they had never been part of the communist world.

The idea that a similar power vacuum could occur in any other major country seems extremely paranoid. But maybe I'm missing your point.

Nov 05 09:34 AM

[derryl:]

Alan,
I think the point is that excessive taxation leads to either state default or state money printing. There are limits to the amount of tax revenue any government can collect. Beyond those limits you get currency problems that are much worse than the problems you were trying to solve with higher taxes. Capital flight could indeed happen in the USA, with the same kinds of consequences.

Nov 05 09:55 AM

[BRUCE E. W.:]

(1) en.wikipedia.org/wiki/...
en.wikipedia.org/wiki/... (1998)

en.wikipedia.org/wiki/...

en.wikipedia.org/wiki/... (1970s -1980s)

en.wikipedia.org/wiki/... (1994)

en.wikipedia.org/wiki/...

bilderberg.org/bis...

en.wikipedia.org/wiki/...

A man of your intelligence and experience should open the scope of your perspective to the wider implications of history. If the world were a "business" I would want you very high up in its organization chart. However, the world is a patterned power scala of leveraged domination and political capture in history. We can not escape the realities of the post "cold war" economic war in balanced power detante; converting back to a class capture of currency domination and its consequences now that the nationalistic agenda is accomplished and the world is more or less being capitalized and in fact captured as a marketed interregional and cross bordered grid.

Privitizing this capture of political economic agency (or the economy of politicizing power, if you will) will be the result of a pure monetarianist system simply by aggressive exclusion and a politicized (policed) reinforcement/ enforcement.

Price theory can not move in two directions. Price theory will stratify society permitting liquidity in a progressively smaller power elite, while constricting currency in the vast majority of the economic demographics. This is not GOING TO happen, it is happening right now.

Excerpt from:
Theft of the Century
Privatization and the Looting of Russia
An Interview with Paul Klebnikov
Jan/Feb 2002 - VOLUME 23 - NUMBER 1 & 2


Paul Klebnikov is author of Godfather of the Kremlin: Boris Berezovsky and the Looting of Russia. He is a senior editor at Forbes magazine and has reported from Russia since 1989. A fluent Russian speaker, he has won four press awards for his writing on Russian business. He holds a Ph.D. in Russian history from the London School of Economics.

"The vast majority of the Russian population got nothing out of the voucher privatization. The people who did benefit ó the insiders and financial operators who bought up all the vouchers ó ended up buying up control of the main enterprises at a fraction of their market value."
Paul Klebnikov: "The idea was that, since the vast majority of industrial assets in Russia were state-owned and hence every citizen had an equal piece of those assets, the vouchers [giving each citizen a proportionate stake in privatizing assets] would be the vehicle by which the state would promote equality in share ownership of those state-owned assets. On the face of it, it’s a very noble idea. Theoretically, it could create a kind of Jeffersonian broad-based middle class of small property owners, who, in turn, would be the foundation for a democratic Russia."

It all went terribly wrong

Up until now it may well be the greatest theft of the last century, but if this happens to the American economy; it will have only been a practice run rehersal for the largest global scheme in the history of all mankind.
At least consider the implications of Naomi Klein's The Shock Doctrine, 2007 Picador, Henry Holt & Co.;
I am also recommending Ellen Hodgson Brown, J.D. ; The Web of Debt, 2008 Third Millennium Press
I assure you that once you start to look...you will not hesitate to listen attentively to current affairs.

Nov 05 12:42 PM

[BRUCE E. W.:]

They seem to have cut the links to my post. In efect they represent one regional crisis after another since the 1970s which follow the same pattern of default and reorganization in both monetary finance and political agency. In effect, they represent a "star wars" scenario of interregional crisis by finance over the past 40 years.

Nov 05 01:17 PM

[jambo:]

On Nov 05 09:34 AM Alan Young wrote:

> Russia in the 1990's, after the collapse of the Soviet government,
> was complete anarchy, with default control falling to a cabal of
> kleptocrats.

Hah! Kleptocrats, I love it. Seldom do I see a word coined so concisely.
I would add to that a description of the taxation monies received by those people as "fuckage" or the amounts they were screwed out of.

The point is, imo, it COULD happen here. The current rate of theft from the creators of wealth in our nation is at once astounding and unbearable.

Nov 06 03:05 PM