Why Sovereigns Default on Local Currency Debt

I’ve had a number of emails and comments this morning on this report from Fitch titled “The money printing myth – why sovereigns default on local currency debt”.  So here’s my view on their paper.

First of all, an MRist should never say that a monetarily sovereign currency issuer can’t default.  One of the key points behind MR is flexibility and specificity with regards to certain monetary systems.  I tend to focus on the USA and have repeatedly said the USA won’t default.  But that’s a very specific case based on a very specific understanding.  Generalizations can be extremely dangerous in the world of economics where there are so many complex moving parts inside the various systems.

We have to be more careful to look at each instance as its own unique occurrence.  For instance, writing long research reports that compare the sovereign debt of ALL countries over the last 100 years and then concluding that 90% debt to GDP is dangerous for all of them, is highly misleading as it doesn’t get granular enough in understanding how that sort of data applies to each monetary system.

For instance, when someone compares the USA to Greece they’re comparing a low output currency using nation to a high output currency issuing nation.  You have to be more detailed than just making vague generalizations.  The details matter!  So what does Fitch’s report tell us?  Well, it shows us that sovereigns most certainly can default on their local currency.  The ability to print your own currency is not always a fix to get out of an economic rut.

The point is, money is not a substitute for having domestic resources, output, etc.  MR focuses a great deal on the quality and stability of output because that’s ultimately what money is used for. Money is not the end.  It is merely the means to an end.  Remember, if money is merely a ticket to enter the theater that is a specific economic “show” then the ability to print more tickets does not automatically mean you can increase demand for the show (it might, at times, but certainly not always!).  If the show is worthless the tickets are worthless regardless of whether you have the ability to make more tickets or not.  The ticket printer isn’t always the solution to the problem!

So that brings us to the point of internal and external constraints.  The Fitch report doesn’t point out that many of the nations cited in their study were on a fixed exchange rate system when they defaulted.  This currency arrangement is essentially a foreign debt situation.  So why would a country ever peg its currency to someone else’s?  Well, not all countries are like the USA with a strong export and import base and a currency that is accepted everywhere.  So it can be advantageous at times for a country to fix its exchange rate to boost growth.  There are plenty of examples of countries who peg their currency to try to boost competitiveness.  Some might call this irrational, but the alternative is the potential suffering of economic growth in the near-term.  Again, the case of American exceptionalism shouldn’t be generalized to all other countries.  I’ve written quite extensively about some of the cases Fitch cites (for instance, see Russian analysis here) and you can clearly see that there are more parts to the puzzle than simply defaulting on domestic debt.  You have to get granular with this stuff.

The bottom line is, all countries can’t be truly sovereign in the same sense that the USA is.  There are real constraints.  And that brings us to a very interesting comment from a friend of mine who works in international banking in South East Asia who works for one of the biggest banks in the world and specializes in selling debt to foreign central banks.  I recently asked him why a country might be inclined to borrow in foreign denominated debt thereby relinquishing their sovereignty.  He said:

“Many countries have to borrow dollars for both internal and external purposes. If their currencies are not freely convertible currencies and/or are not accepted by the other party or parties in payment for goods or services, the country has to borrow dollars to meet such obligations. If the country generates dollars, euros, yen, sterling, swiss francs, etc. from its exports, then it may not need as much in borrowings as those who do not. A good example is virtually any oil based economy. They generate huge amounts of dollars that are then used for infrastructure projects lie roads, dams, power plants, housing, etc. These projects are predominantly undertaken by foreign contractors and they want to be paid in dollars or yen, etc.

At the same time, countries have to have foreign exchange available to meet the demands of their corporations and to a much lesser degree their populations. When a company needs to buy product or raw materials or pay for services rendered that are priced in dollars, they need to buy that foreign currency from their local banks who in turn, have to buy from the Central Bank or another bank that will buy the local currency against the foreign currency.

Now the Philippines is an exporter of rice, textiles, furniture, labor (loads of maids, nannies, construction workers and ship crews to other parts of Asia and the Middle East), etc. which generates dollars but not enough to pay for all the projects undertaken by an expanding Lesser Developed Country (LDC). Same was true and remains true for most developing countries today. So they need to go out and borrow Balance of Payments or Infrastructure loans from the IMF, the World Bank, the private market (like the international bank markets and the bond markets) to source their foreign exchange.

I’d also add that it’s not strategically viable to avoid a fixed exchange rate policy at all times. Many LDCs are essentially forced to run a fixed exchange rate because their domestic economy is not strong enough. They can’t attract foreign investment so printing money is out of the question since it would simply cause high inflation. So they peg their currency to a stronger trade partner, attract investment, and can achieve higher growth levels without much of the inflation worries that would arise from just printing money. In other words, they don’t have the supply of goods to sell to their own domestic economy so they essentially import the goods (temporarily) produce them domestically, attract the investment, wages and jobs and then export the goods. This approach is the only viable growth option for many LDCs.”

Not everyone has the luxury of a diversified economy that exports the GDP of Russia every year (as the USA does).  So we have to be careful with these generalizations.  Can a sovereign currency issuer default on their domestic debt or run into severe internal or external constraints – you bet your ass they can.  Are there times when a country might be forced into borrowing a foreign currency because of inherent constraints?  Yes.  So the specifics matter and we should be careful about extrapolating generalities out across the entire spectrum of monetary systems in the word.  No two systems are exactly the same….In my opinion it’s wrong to state that a sovereign currency issuer can never default.  But it’s equally misleading to imply that all debt is the same across all countries.  The details matter.




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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • LVG

    The annoying thing about working from the foundation of an ideology is that people tend to generalize to prove their points.

  • Gareth

    Wait a second, are you agreeing with your friend, that it’s quite simple to create inflation by printing too much money?

  • http://www.concertedaction.com Ramanan
  • http://orcamgroup.com Cullen Roche

    Depends. But yes, a country could certainly create very high inflation by simply spending in excess of its productive capacity.

  • http://orcamgroup.com Cullen Roche
  • Mike

    A good Read on this subject is “It’s Different This Time”.

    There is also a cultural element in that, the Anglo Saxon Countries repay their bonds, so of the others are trying to learn to, and some do not.

    The best predictor of future behavior is past behavior.

  • http://www.concertedaction.com Ramanan

    Good direction.

    A nation which truly floats its currency can find itself in a position where its central bank needs to intervene in the fx markets. For this the central bank needs resources and borrowing in foreign exchanges. This can happen when the balance of payments position starts to deteriorate.

    This was observed by commentators in the early 1970s.

    Few nations have floated truly but that is the result for the superior competitiveness in international trade rather than their purely their own volition. Which is to say that it is asking too much for a country to truly float its currency.

    There is no such thing as a solvent government. It is conditional on various things.

  • http://www.concertedaction.com Ramanan

    Will check but don’t think the UK defaulted in 1976. It just needed IMF’s help.

    Your quote for your South East Asian friend is nice. Nations struggle to float their currencies and have debt in foreign currencies (govt debt). This is also called the “fear of floating”.

  • http://orcamgroup.com Cullen Roche

    Sounds right. They just needed IMF aid to support the FX rate. Still, the point in the UK is that countries need access to FX as you mention and if they can’t get it then they rely on foreign aid. Pretty sure you and I are seeing this from the same angle….

  • Steve W

    Mosler posted comments on the Fitch report too. Keep up the good work, Cullen.

    By the way, somebody (on another blog) accused me of being a proponent of MMT. I’m happy to say that I’ve learned enough from you (and Mosler) to explain why I was not truly a member of the MMT crowd. This was fun, it was on a progressive (“liberal”) blog, with comments prompted by an article about austerity that included quotes from Professor Kelton. If MMT is being discussed on left-leaning (progressive, liberal….whatever the correct term is…) blogs, then maybe we’ll see stuff about MR before too long.

  • Entenschnabel

    I don’t think I disagree but would word it differently. No sovereign ever gets into a position where it CANNOT pay it’s domestically denominated debts – but under some circumstances they might CHOOSE to default rather then “print up”. It’s a default option.

  • The Dork of Cork.

    Sounds very much like a propaganda piece from where I am standing.

  • The Dork of Cork.

    “For instance, when someone compares the USA to Greece they’re comparing a low output currency using nation to a high output currency issuing nation…………
    Low output ? high output ?
    WTF is that without context

    A countries output is mainly a result of its capital (energy) ration.

    Its not really heavily a result of it people , unless they are 18th century Inuit tribe thrust into the nightmare world of the 21rst century.

    Pretty much any country with enough BTU and they can give you a hell of a lot of output.
    Be it useful grot or not.

    Its not some sort of natural or national condition.

  • http://www.concertedaction.com Ramanan

    The UK runs into a balance of payments crisis. The IMF requires the UK government default on debts in domestic currency to lend foreign exchange. (A bit like Cyprus being required to have bank depositors take a haircut).

    “No sovereign ever … CHOOSE to default” – nice words!

  • http://orcamgroup.com Cullen Roche

    The USA’s massive output has gifted them with the ability to maintain a currency that is accepted almost anywhere. If I say “reserve currency” then people just assume that the USA has been gifted some status based on nothing. But it’s not nothing. It’s the result of 25% of the world’s output being produced by that nation. Greece has no such benefit.

  • http://orcamgroup.com Cullen Roche

    Well, no nation ever HAS to peg their currency either, but if they don’t it could be catastrophic for the economy in some circumstances. There seems to be an implicit assumption in some circles that anyone can remain sovereign without anything bad going on in their economy. These people tend to reside in academia in large developed nations and don’t reach out to enough people like my banker friend who lives in undeveloped nations doing specifically what some people say central banks shouldn’t do (but obviously must).

  • The Dork of Cork.

    Whats the US current account deficit again………remind me , whats its physical goods deficit ?

    Output – input = net production

    The US & UK is a Imperium.
    You benefit from being at the top of the castle.

    The euro system is the Anglos India.

    A surplus area or hinterland.

    This world we live in is very 1913.

    Japan is nice France
    China is hostile Germany
    Europe is surplus goods India – the jewel in the crown.

    The BoE sat over South African & Canadian mines in 1913

    The gold flowed out for real goods.
    A real goods deficit.

    Both France and Germany held most of the worlds above ground gold back then.
    Now Japan & China hold Treasuries……..

    Whats the difference.
    Same shit
    Different century.

    You are not a republic
    You are the base of operations for the Venetian banking system.

    Germany got pissed after a time – it had no use for Gold.
    BoE said we will give you more , we are good for it.

    But it wanted Oil for its own budding Imperium.

    Then the shit hit the fan.

  • The Dork of Cork.


    Impressive slowdown in the deficit.

    But it remains.

    You will notice the IMF chief shareholders Of US ,UK & France remain in current account and balance of trade deficit.

    Given the high oil price other countries must adjust their systems in a even more extreme manner.

    This crisis is obviously a global balance of payments and final settlement crisis.

  • The Dork of Cork.

    I had a piece comparing the Anglo crisis of 1913 /14 to the crisis of today………..100 years after

    It seems to have not appeared on this board.

    Funny that.

  • http://www.concertedaction.com Ramanan

    Right. And developed countries’ economists do not understand the reasons for their success.

    And nations who manage to TRULY float are the ones whose currency is highly acceptable and is a result of relatively high international competitiveness.

    The “come what may, keep floating without intervening in foreign exchange market” (and hence no official foreign currency liabilities) assumes that nations are self-sufficient and that foreign exchange markets always clear and there is “always a price” (exchange rate).

    When the Bretton Woods fell apart, nations quickly learned that there is hardly a thing called truly floating and central banks were forced to intervene.

    Hence we have “exchange stabilization fund” run by the Treasury which manages assets and liabilities in foreign currencies and the need for borrowing in foreign currency.

    Some nations have escaped intervening but this has been the result of relatively strong export/trade performance. And they are developed because of the external trade performance. In fact the success of nations is explained by little else.

  • Anonymous

    That isn’t why the US dollar is a reserve currency

  • http://www.concertedaction.com Ramanan

    “This crisis is obviously a global balance of payments and final settlement crisis.”


    It is funny how economists worry too much about inflation. Although it is a problem, the problems of the world lie elsewhere.

    In fact, “deflation causes inflation”. If the world did not have this deflationary bias, production would rise fast and hence productivity as well – as per Kaldor-Verdoorn effect and will somewhat tame inflation.

  • The Dork of Cork.


    I would like to engage with you , but some of my comments disappear in the ether and therefore the stuff can gets through losses its context.

    I suspect censorship.

    Once you mention the dynamics are very similar to 1913/4 it seems to get censored for some funny reason.

  • Luke

    How we define “sovereign” is likely an issue. An independent country may decide pegging to a stronger nation’s currency is in the national interest. In that case, the country surrenders the ability to conduct independent fiscal and monetary policy. That means the country chooses to be sub-sovereign, comparable to US states and Eurozone “countries.” Just as US states are highly prosperous despite not possessing sovereignty, pegging to a stronger country’s currency may be a good decision in many cases depending upon the circumstances. But the key point is that being an independent country is very different than being a sovereign country. In the example used of LDC countries pegging to the USD, I don’t think it’s correct to describe those LDCs as sovereigns. They could become sovereign by breaking the peg, but while the peg is intact, they are sub-sovereign. When LDCs are sub-sovereign, they are vulnerable to default. When LDCs are sovereign, they are vulnerable to inflation. No free lunches.

  • Hoffa

    Scenario 3 is interesting and of course a possibility, however extremely remote. The IMF insisting on the UK defaulting on its foreign GDP dominated dept? Only if the Russians owned all of it. The IMFs role in a financial crisis is to make sure foreigners getting paid at the expence of the domestic poor. In fact, most of the time they will also insist the captured country to sell assets to foreigners at distressed prices. Still thanks for the post, rare to find intellectual enhancing material so amusing.

  • Hoffa

    England is said to only have defaulted when Edward Longshanks was king, the US never. However, I would call it a default if you choose to abandon a currency peg, either to gold or another foreign. In that respect both UK and the US have defaulted.

  • http://www.highgreely.com jldasch

    Yes, I think Luke has it described mostly correctly. However, being vulnerable to inflation is purely a function of the rate of money creation in a semi-closed system relative to real productivity in that system (relative to world available for trade to that system). Any closed system can exist stably with any rate of inflation or deflation, but as soon as it’s connected to another system this goes away.

  • Mr. Market

    The article overlooks that Ecuador defaulted on its detbs in november 2008 as well.

  • Blobby
  • http://www.concertedaction.com Ramanan

    Sorry didn’t check back but your comments disappeared as you say. I know less about 1914 though.

  • Andrew P

    I think the Pragcap commenting system traps certain keywords for moderation. Lots of systems work like this. Your comment has appeared now.

  • Andrew P

    There are various levels of sovereignty. I would say a country is not truly sovereign unless it is an Imperium, has a high degree of economic output and self-sufficiency, and possesses the full complement of the Money Power. The USA meets all three criteria.

  • Pierce Inverarity

    “I suspect censorship.”

    I suspect you’re paranoid.

  • http://orcamgroup.com Cullen Roche

    Funny, just for kicks I censor the word “censor”. :-)

  • http://www.nowandfutures.com bart

    The budget deficit is far from the differences in total debt, due to failures to include off budget items.


  • http://none alan greenspan’s skeleton

    This is a great article Cullen and I think you hit the nail on the head. People too often use their butter knife instead of a scalpel to cut through the surface to look at what really occurred during a sovereign default. Often it was the peg that played a role in the default (again every case is different though). This has me continually coming back to what is happening in Japan. While I don’t view a default as a major risk per se, I am concerned about inflation actually being created by way of an uncontrollable Yen drop. The reason why is this: (I wrote this response last month under another article you wrote regarding Kyle Bass’s JGB short)

    When the bond market becomes an internal circle-jerk (much as Japan’s is), the “checks and balances” offered by external investors are removed. This does not guarantee destruction if the nation is thriving. One should then consider what happens to the exchange rate of the nation, as this is where the checks and balances will transfer. Yes, technically a Chartalistic nation can never go bankrupt, but this is meaningless if the nation is not self-sufficient from a resource perspective. If the nation relies on imports and runs a current account deficit then relative international inflation (degrading rate of exchange) will cripple the nation and trigger social chaos. On the other hand, if the nation is thriving, the effect may even be positive as foreign investors, eager to parasite on the nations strength must invest via other channels than the sovereign debt market. Furthermore, outcomes depend on the additional factor of whether or not a government abuses its power under chartalism which is, again, not guaranteed but is dependent on the finer details of politics, citizen accessibility and education. The US was chartalistic under Lincoln (the origin of the Greenback), it was no Zimbabwe. Things aren’t as black and white as Bass presents it.

    Japan could experience inflation if their currency continues to nose dive. I think we can all agree that the achilles heel of MMT/MMR is inflation. It suggests that in order to combat it you have to raise taxes and or hike interest rates depending on what is going on. Japan can’t do either of these but it wouldn’t matter because if they do get inflation, there is the very real possibility of the bond market cracking and by that I mean interest rate spikes. For how long and how high I don’t know but what then would happen to the currency? it would continue to nosedive forcing the BOJ possibly into a draconian Yen peg via the Swiss Franc but could it work for the world’s third largest economy? I don’t know but I do not believe Bass is making a dumb bet at all.