A reminder of how risky “risk-free” assets can be…

In the 1930s and 1940s the default of a developed country sovereign was not uncommon. This is really difficult for us to grasp (we would have to be 80 years old to have experienced it). So just to remind you of how possible sovereign defaults are, here we present a list of (external currency) soveriegn bonds that defaulted during the 1930s:

 

Sovereign Bonds in USD or in GBP Listed on the NYSE That Defaulted in 1931–1938:

 

  • Austria International Loan 7s of 1930 – Defaulted 31 May 1938
  • Bolivia National Government 6s of 1917 – Defaulted 1 April 1931
  • Bolivia National Government 7s of 1927 – Defaulted 1 January 1931
  • Bolivia National Government 7s of 1928 – Defaulted 1 March 1931
  • Bolivia National Government 8s of 1922 – Defaulted 1 May 1931
  • Brazil Federal Government 8s of 1921 – Defaulted 1 December 1931
  • Brazil Federal Government 7s of 1922 – Defaulted 1 December 1931
  • Brazil Federal Government 6.5s of 1926 – Defaulted 1 April 1932
  • Brazil Federal Government 6.5s of 1927 – Defaulted 15 April 1932
  • Brazil Federal Government 5s of 1931 – Defaulted 1 January 1938
  • Bulgaria National Government 7.5s of 1928 – Defaulted 15 November 1932
  • Bulgaria National Government 7s of 1926 – Defaulted 1 July 1933
  • Chile National Government 6s of 1926 – Defaulted 1 October 1931
  • Chile National Government 6s of 1928–January 1961 – Defaulted 1 January 1932
  • Chile National Government 6s of 1927 – Defaulted 1 August 1931
  • Chile National Government 6s of 1928–September 1961 – Defaulted 1 September 1931
  • Chile National Government 6s of 1929 – Defaulted 1 September 1931
  • Chile National Government 6s of 1930 – Defaulted 1 November 1931
  • Chile National Government 7s of 1922 – Defaulted 1 November 1931
  • Colombia National Government 6s of 1927 – Defaulted 1 July 1933
  • Colombia National Government 6s of 1928 – Defaulted 1 October 1933
  • Costa Rica National Government 7s of 1926 – Defaulted 1 November 1936
  • Costa Rica National Government 7.5s of 1927 – Defaulted 1 September 1937
  • Costa Rica National Government 5s of 1932 – Defaulted 1 November 1936
  • Costa Rica National Government Pacific Railway 5s of 1933 – Defaulted 1 September 1936
  • Cuba National Government Public Works 5.5s of 1930 – Defaulted 31 December 1933
  • Cuba National Government 5.5s of 1927 – Defaulted 1 July 1937
  • Dominican Republic National Government 5.5s of 1922 – Defaulted October 1931
  • Dominican Republic National Government 5.5s of 1926 – Defaulted October 1931
  • Germany National Government 7s of 1924 – Defaulted 15 October 1934
  • Germany National Government 5.5s of 1930 – Defaulted 1 December 1934
  • Greece National Government 7s of 1924 – Defaulted 1 May 1932
  • Greece National Government 6s of 1928 – Defaulted 1 August 1932
  • Greece National Government 8s of 1925 – Defaulted 1 October 1932
  • Guatemala National Government 8s of 1927 – Defaulted 1 November 1933
  • Hungary National Government 7.5s of 1924 – Defaulted 1 February 1934
  • Panama National Government 7s of 1927 – Defaulted 31 July 1932
  • Panama National Government 5s of 1928 – Defaulted 15 May 1933
  • Peru National Government 7s of 1927 – Defaulted 1 September 1931
  • Peru National Government 6s of 1927 – Defaulted 1 June 1931
  • Peru National Government 6s of 1928 – Defaulted 1 April 1931
  • Poland National Government 6s of 1920 – Defaulted 1 October 1936
  • Poland National Government 8s of 1925 – Defaulted 1 January 1937
  • Poland National Government 7s of 1927 – Defaulted 15 April 1937
  • Romania National Government 4s of 1922 – Defaulted 1 October 1933
  • Salvador National Government 7s of 1924 – Defaulted 1 July 1932
  • Salvador National Government 8s of 1923 – Defaulted 1 January 1933
  • Uruguay National Government 8s of 1921 – Defaulted 1 August 1933
  • Uruguay National Government 6s of 1926 – Defaulted 1 November 1933
  • Uruguay National Government 6s of 1930 – Defaulted 1 November 1933
  • Uruguay National Government 5s of 1915 – Defaulted 1 January 1934
  • Yugoslavia National Government 8s of 1922 – Defaulted 1 November 1932
  • Yugoslavia National Government 7s of 1922 – Defaulted 1 November 1932

 

Source: A Century of Sovereign Ratings

 

See here for our collection of rare historical economic data.

Posted Feb 3, 2013
  • rafael barbieri

    What does it mean for a sovereign bond to default?  A sovereign bond is an agreement to swap the government liability, an interest bearing security,  for another government liability, a non interest bearing security.  Would a default then constitute the failure to live up to this agreement?  If one distinguishes from ability to adhere to the contract from willingness, how would a freely floating sovereign monetary authority that has power to enforce and change the monetary laws be unable to meet their obligations?  Clearly it can be unwilling to agree due to a compromising future position.  

    Perhaps if one defines default as a party’s inability and unwillingness to adhere, then potential default is plausible.  However, if one excludes willingness from the definition, as it is a voluntary act, then default in this sense does not seem possible.  

    This isn’t to say that this removes danger from the monetary system.  It does change the story of its demise.  

    I haven’t done enough research on the types of monetary systems that were involved in the defaults above.  Are these sovereign bonds all alike in some nature?  Are they anything like today’s versions?  Were the defaults due to inability or unwillingness to pay?

    It becomes a bit more complicated when thinking about inability v unwillingness in the context of a monetary system that is pegged to a currency or precious metal.  The EZ offers a glimpse as to why not all sovereign bonds are created equal.  That is if you consider EZ nations sovereign at all seeing as they do not have their own monetary systems.  

    Clearly Italian sovereign bonds and US sovereign bonds are not nearly the same types of assets.  If a EZ national default were to occur and added to the lists of “sovereign” defaults, a future researcher would  not be able to understand the nature of the event or asset without the context of the monetary system and laws.

    This post is not meant to disprove your point above.  In reality all I seek is a better understand of the nature of such events and the events taking place currently.  This will be a vital importance when managing expectations of what the future may look like without being overly bias to the present. 

    Very much appreciate your work over the years.  Keep it up!  We are all learning through what may be considered truly historic times when future generations look back at this present.  

    • Greshamslawcom

      Hi Rafael,Thanks for your response.

      If one distinguishes from ability to adhere to the contract from willingness, how would a freely floating sovereign monetary authority that has power to enforce and change the monetary laws be unable to meet their obligations?  Clearly it can be unwilling to agree due to a compromising future position.

      Perhaps if one defines default as a party’s inability and unwillingness to adhere

      I think “willingness to pay” is absolutely relevant here and it’s really difficult (if not impossible) to break it apart from the “inability to pay”. For instance, if a government does reach the Keynesian Endpoint, having an interest expense that exceeds its revenue, then it still *can* print. However, at some point they’re going to realize that every time they do the market only bids down their bonds (increasing their interest expense) thus making the situation very practically worse (i.e. they have to borrow exponentially increasing amounts on short timeframes). When they default some might call it “unwillingness” and some might call it “inability” to pay. 

      • http://www.facebook.com/profile.php?id=18502398 Rafael Barbieri

        First of all thank you for the response, much appreciated.  

        “For instance, if a government does reach the Keynesian Endpoint, having an interest expense that exceeds its revenue, then it still *can* print.”
        If the interest expense exceeds the “revenue” it would most likely be due to a failure to collect an appropriate amount of taxes (fiscal policy) during a time where price inflation has caused the Central Bank to raise interest rates.  When the government taxes it reduces the supply of treasury liabilities outstanding (bonds).  As this occurs, the total interest expense declines at the given interest rates.  Again, rising price inflation is what would cause the Central Bank to provoke such a situation as the market participants for treasury bonds would not be able to trigger such a move.  

        This is more a failure of fiscal policy in the face of rising inflation and interest rates.  If nothing were done to make the proper policy adjustments, currency revulsion by market participants is more than logical.  In the event of currency revulsion, market participants are signalling that there is far too much money creation occurring by the private banking system (given the productive capacity) as inflation has taken hold.  Taxation is more than appropriate unless the system can quickly increase production.  

        Another scenario would be a situation where tax revenues collapse due to a contraction in economic activity.  Unless the productive capacity is destroyed, in other words unless the real economy is impaired, this would most likely result in a debt deflation/ liquidation cycle/ credit crunch.  At this point, it would be logical for market participants to bid up the price of existing treasury securities while exiting far riskier assets out of fear of loss.  This event would push up treasury security prices indicating that it is more then safe for the treasury to begin to issue new securities as private participants may be in short supply. Actually, if tax revenues were to collapse this process would most likely automatically happen as automatic spending, such as unemployment insurance, would go into effect.    

        “I think “willingness to pay” is absolutely relevant here and it’s really difficult (if not impossible) to break it apart from the “inability to pay”"

        It might be difficult, but a main difference is if an issuer of a liability promises to return a foreign asset that is not within its control.  That is true of all issuers of IOUs not solely a national entity.  The US issues securities that delivers one government liability (a treasury security) for another (a US dollar denominated bank account balance in the form of Fed reserves).  As Congress works through the Fed and the privatized banking system in order to carry out the monetary laws, Congress has “explicit*” control.  It cannot ever be unable to pay in this sense.  This is in stark contrast to any EZ nation where they have made promises against a “foreign” currency, the Euro.  They are not fully sovereign states.  

        Looking forward to a response!

        *Now, in reality it would seem that the Banking system has captured this system and is able to dictate to Congress.  That is another topic.  

        • Greshamslawcom

          If the interest expense exceeds the “revenue” it would most likely be due to a failure to collect an appropriate amount of taxes (fiscal policy) during a time where price inflation has caused the Central Bank to raise interest rates.

          I would say it’s more generally about a government’s average debt cost and their interest expense as a % of revenue. For example in Japan, it comes from years and years of refinancing at lower and lower rates while nevertheless increasing the proportion of its revenues that pays for interest. Over time they’ve got to a situation where just a small shift away from “normal conditions” (e.g. drying up corp. profits and household net new savings) can increase average debt costs to the point where interest expense > revenue.

          Again, rising price inflation is what would cause the Central Bank to provoke such a situation as the market participants for treasury bonds would not be able to trigger such a move.

          Well I would say more generally that it’s whenever the demand/supply situation in the bond market moves appropriately. 

          It might be difficult, but a main difference is if an issuer of a liability promises to return a foreign asset that is not within its control.  That is true of all issuers of IOUs not solely a national entity.  The US issues securities that delivers one government liability (a treasury security) for another (a US dollar denominated bank account balance in the form of Fed reserves).  As Congress works through the Fed and the privatized banking system in order to carry out the monetary laws, Congress has “explicit*” control.  It cannot ever be unable to pay in this sense.

          Yes I agree. The only thing is; if you get to that “keynesian endpoint” you’re getting into a territory where the value of a currency is getting hammered to such a degree that they feel that they are “unable”. Mechanically, though, I agree that they could always make the decision to print… only at their own peril…

          • http://www.facebook.com/profile.php?id=18502398 Rafael Barbieri

            “drying up corp. profits and household net new savings.”

            Well where do nominal savings coming from for the entire private sector?  On aggregate savings between the all sectors, private, public, foreign must net to zero in money/nominal terms.  Savings in real terms is another matter, but is the most important.  Real savings aka an increase in  productive capacity, human capital, technology, factories, schools, etc is what we should really strive to increase.  Isn’t it?

            “I would say it’s more generally about a government’s average debt cost and their interest expense as a % of revenue. ”

            In this regard, the government has two options which are contingent on real economic environment and private financial conditions.

            If the credit/security creation process is increasing more rapidly than productive capacity, a rapid rise in inflation will take hold.  Here it make sense to raise interest rates.  The government could also tax, which reduced the net supply of assets held by the private sector.  It can also spend less, emit fewer financial assets/ treasury bonds into the private sector.   If the government raises rates and runs a budget surplus, the total interest expense will be smaller due to fewer bonds outstanding while revenues increase.  This is more than appropriate during an inflationary cycle.  If this is not done then the fears of currency revulsion are definitely warranted.  As we have seen, it is more likely that private credit creation and an asset bubble will have driven this situation which has proven to be unsustainable.  However in a disinflationary/ private credit deflationary cycle, it has become clear that the Central Bank can reduce interest expenses by targeting lower rates without causing currency revulsion   Investors are more than willing to hold relatively safe interest paying assets, treasury bonds, even at low nominal rates in a low inflation environment.  What is the alternative for investors?  Private sector corporate bonds?  Shares?  In a period where nominal growth is low which could tip into credit destruction similar to the 2007-2009 period, treasury bonds are much safer than either of those alternatives.  At least a treasury bond can’t be destroyed where clearly certain private securities, MBS, can be.  In a financial crisis, which would you rather hold, treasury bonds or junk bonds?   Would you rather hold an Greek debt security or a treasury bond?  I know which I would pick.  Investors are willing to acquire such assets at negative real rates for a reason.   At different points in the last 4 years there has been tremendous demand for treasuries.  By implementing QE, the Fed has removed treasury bonds in exchange for fed reserve balances.  This forces investors to seek yield.  That seems to be the real danger of such policy.  If there is another private credit event, the Fed should be partially held responsible for sparking this behavior.  I cannot go a month without hear about how certain individuals cannot make ends meet while simultaneously money managers reach out in order to acquire higher yielding securities.  Isn’t this the reach for yield attitude the same one that lead to the financial crisis?  

            “Well I would say more generally that it’s whenever the demand/supply situation in the bond market moves”

            Wouldn’t you say this is a second order effect?  What would cause a bond holder to sell?  To buy?  To hold?  Wouldn’t it be inflation/deflation, the private alternatives (private debt instruments and shares), and nominal interest rates?  What are investors signalling now in the US?  Again, in nominal savings terms, what financial assets would you prefer to hold in a situation that is as perilous as today?  

            Could conditions change?  Absolutely.  If the treasury/CB failed to respond appropriately, currency revulsion could absolutely take hold.  Right now, in speaking to the general public, what they lack is money.  It seems that most households are incredibly cash poor while they struggle to service massive amounts of debt they compiled during the private credit bubble.  This is hardly conducive to a rapidly rising inflation environment.  From my private conversations, many have been unable to increase savings enough  over the last few years as they have either suffered unemployment or have had their wages reduced/ hours cut.  In this environment what would you rather hold, treasury bonds or assets that consist of private sector household liabilities?  How did mortgage back security holders feel during the crisis relative to the treasury bond holders?  How would Spanish, Italian, Greek bond holders feel if there is a credit crisis/deflationary event in the EZ?   

            Again, this environment does not seem conducive to excessive risk taking/ new private credit creation.  No wonder the corporate sector has been so reluctant to part ways with their dollar denominated cash balances give collapse in private investment since the crisis.  Maybe this has to do with the fear of not being able to access the credit markets during a crisis period after that had occurred in 2008 for some.  

            I’ve tried to work through the ”Keynesian endpoint” so many times.  It only seems to exist if governments completely mismanage their liabilities, Fed reserve balances and treasury bonds, during an inflationary/growth period.  Even here it isn’t a result of insolvency but currency revulsion.  Well there is one scenario, but that involves real economic destruction where productive capacity is severely impaired.  If anything, productive capacity globally is being enhanced by an infusion of technology.  It is telling that even in the US with very high levels of unemployment, the economy can produced at higher capacity given new tech.  Corporations admit that they are not producing at nearly full capacity.  Again, this environment does not seem conducive to run away inflation.   

            • http://www.facebook.com/profile.php?id=18502398 Rafael Barbieri

              Thoughts?

              • http://www.facebook.com/profile.php?id=18502398 Rafael Barbieri

                Disappointing.  I was hoping that someone would want to examine these social constructs and question a few commonly held assumptions!  Guess that is not going to happen!

  • rafael barbieri

    Also the fact that the assets default implies that they were not “risk free” assets in the first place.  

    If one includes unwillingness as a risk, then there can never be such a thing as a “risk free” financial asset.  Even a security issued by the safest issuer in the history of all issuers can not be considering risk free in this sense considering the issuer may at one point in the future be unwilling to meet their obligations for not rational reason at all.  That could be to be unwilling for the sake of being unwilling.    

    Considering a financial security is nominal in nature where inflation (its value relative to real produced thing) is real, inability would not relate to real effects.  An issuer may not want to meet their contractual obligation due to the potential for the relative decline in value (against real things) of their existing liabilities held by others, but again this is a question of willingness.  Furthermore, if one defines depreciation as the fall in value of a nominal claim against another but different nominal claim, then this would also speak to unwillingness.  An issuer might be unwilling to meet their obligation due to the possibility that in doing so they will cause a depreciation in their nominal liabilities which they issue as securities held by another as an asset.  

    Now if one were to compare the relative risks between securities, one would probably do better selecting one where the risks are limited to only unwillingness.  Thus, selecting a security where the issuer of the liability only accepts another of its liabilities in exchange with the promise that they will adhere to the promise to reverse the transaction at some point in the future, may be better than selecting a security where the issuer promises to return a “foreign” liability at some point in the future.  

    Ex. of the former is the US treasury.  

    The US treasury issues a liability in the form of a treasury dollar denominated bond in exchange for a dollar denominated commercial bank deposit balance.  The deposit balance is credited to the treasury’s account held at the Fed.  The Fed is a construction of congressional legislation.  At this point the commercial bank can exchange the treasury bond to either the fed in exchange for a fed liability (a reserve) or the bank can trade it to a private sector agent in exchange for the ability to extinguish their outstanding liabilities.    

    As far as the sovereign is concerned which is represented by the treasury in the above example, it can never fail to meet its obligations because the entire construct is created by monetary laws it sets.  To not meet its obligations due to unwillingness is to alter the existing nature of its monetary system.  

    This is clearly different than a EZ nation.  Take the Italian government for example; it is issuing its liabilities in the form of Italian bonds in order to acquire a security it has no control over.  The securities Italy looks to acquire are Euro denominated bank deposits.  The Italian government may always be willing to meet its obligations but its ability is contingent on factors outside of its control namely the private banking system which it has no legislative power over.  

    In this case both liabilities, the US treasury bond and Italian bond are very different financial assets.  They are similar in name only.  

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