Historical Perspective on Government Debt

by: Dr. Bill Conerly

There's nothing like a good financial crisis to make me yearn for historical perspective.  I got just that in a paper called "This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises" by Carmen Reinhard (University of Maryland) and Kenneth Rogoff (Harvard).

Countries default on their debt fairly often when the countries are young, but tend to become more responsible as their economies mature. England, for example, defaulted in 1340, 1472, and 1594, but fulfilled its obligations after that. France had eight defaults in the 16th, 17th and 18th centuries, but after 1812 had no more. France, the authors tell us, had a habit of beheading its domestic creditors, which one imagines could make it more difficult to underwrite a new round of debt. Newfoundland, I had not realized, was an independent country up until its 1936 default.

Defaults tend to be associated with the lows in commodity price cycles. This should make us nervous as commodity prices are in an up-cycle.  Bankers will tell you that they never make bad loans in bad times; they make bad loans in good times.

Inflation is another way to repudiate debt. The old inflationary mechanism was to reduce the silver (or gold) content of coins, but the invention of paper money facilitated the process. Here's their conclusion on inflation:

As with debt defaults, the last few years have been a relatively quiescent period in terms of very high inflation, although many countries (including Argentina, Venezuela and of course Zimbabwe) still have very high inflation. Many observers, following the same logic as in commenting on external default, have concluded that “this time is different.” Perhaps, but, as with debt defaults, experience suggests that quiet periods do not extend indefinitely.

The paper is good, though written in an academic style.  However, the authors omit the mathematics that make most economics papers impenetrable to the layman.