Debt Do-Do

Many nations in the developed world are in deep do-do with their debt levels. On one hand they need growth to earn their way out of their problems, while on the other they're being forced into anti-growth austerity measures by markets, concerned about their spiralling interest obligations. It's a grim position for those of us brought up to expect an unrelentingly rosy economic outlook.

This isn't a new situation, though. We've been here many, many times before and governments have, by design and evolutionary accident, developed many, many ways of dealing with these problems. The cunning thing is that many of these involve stealthily thieving from their own citizens, but done so surreptitiously that, if we're not careful, we won't even notice it.

Face Chewing Mosquitos
One of the things that's being lost in the welter of rhetoric around the debt crises of sovereign nations is that these are not normal debtors, and government debt is not the same as personal debt. If you or I are in debt we're obliged to fulfil the terms of our repayment obligations or to go bankrupt or to pretend to die and go off and live on the life insurance. A country in the same situation has a range of other measures available to it; for us the law is an immovable object, for a government it's simply another variable where its own citizens are concerned.

Bond holders in General Motors and Irish junior bank debt have already found this to their cost. In their analysis of the risks associated with these investments they took the existing framework of obligations – both legal and common practice –  as a given. Unfortunately for the bondholders, when the finances of GM and the Irish banks imploded and their respective governments were forced to step in, these "obligations" turned out to be rather less obligatory than the bondholders would have liked, as the politicians favoured their own preferred creditors, taking the view that without government funding the bondholders would have been wiped out anyway.
Bondholders were angered, possibly with just cause, but in part they only had themselves to blame because they'd failed to understand the rights of sovereign governments to interpret, or even change, the legal framework within which they were operating. Political risk is something less sophisticated investors need to try and avoid, if at all possible.  To…

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