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US to repudiate foreign debt?

October 29th, 2002

Although there’s little in it that hasn’t previously been published by warbloggers like Steven den Beste, I found this piece by William Safire pretty startling. After all you can find just about anything on the web, whereas Safire clearly represents an influential strand of thinking within the US Administration and is writing in the New York Times.
Safire explores the warbloggers’ preferred scenario, in which the UNSC fails to accept a US resolution incorporating the term ‘material breach’ * and the US goes to war unilaterally. Safire envisages an old-style war of conquest in which a puppet government is set up (he doesn’t use the term, but he assumes the government will pursue predetermined policies that harm Iraq and help the US) and used to reward putative allies (Turkey, for example, is supposed to get royalties from the Kirkuk oil fields) and punish non-allies (the ‘corrupt’ debt to Russia is to be repudiated). Meanwhile the US and Britain get Iraq’s oil and pump like crazy, reducing world oil prices by a third.
I want to focus on just one element of this plan – the repudiation of debt on political grounds. Although Safire describes this debt as ‘corrupt’, it’s clear that, in his model, the debt would be repaid if the Russians backed a US invasion. So his proposal amounts to selective repudiation of the debts of a US-controlled government.
In writing about the relative merits of US and European government bonds a day or two ago, I mentioned the possibility of repudiation for the sake of logical completeness, but only to dismiss it as unthinkable. As of today, that is no longer the case. The occurrence of a chain of events leading the US to default on its own debt remains highly improbable, but it is no longer unthinkable.
One possible chain would run as follows. After an Iraqi repudiation dictated by occupying US forces, the Russians retaliate by selectively repudiating debts to the US or by seizing US assets. European financial institutions continue lending to Russia, so the Americans try to recover their losses from them. At some point in the process, wholesale panic breaks out and the US decides either to repudiate or to inflate its way out of trouble by printing unlimited numbers of US dollars.
In thinking about all this, it’s important to remember that the US is by far the world’s biggest debtor and borrower, whether we focus on the US government or the US economy as a whole. In 2003, the US will need to borrow around $500 billion from foreigners (mainly Europeans and Japanese) to balance its current account deficit. The Federal government budget deficit will account for about half of this, and with US household savings near zero, much of it will have to be financed directly by overseas borrowings. In these circumstances, even a slowdown in lending to the US could prove disastrous.
I regard the repudiation scenario as highly unlikely, in part because I don’t think it will get past the first hurdle. It appears unlikely that the proposed US resolution will even get enough support to require a veto from what Safire calls ‘the Paris-Moscow-Beijing axis of greed’. In these circumstances, while the US may be willing to go to war to defend the words ‘material breach’ it’s doubtful that crucial allies including Turkey, Qatar and the UK will go along. The US needs at least two of these, and probably all three, for a successful war. As regards Australia, it seems very probable that Labor would oppose participation in an invasion under circumstances of this kind. The government has been making noises of support for the US, but I suspect that they would try to sit on the fence if at all possible, rather than take part in an exercise like this.
So the prospect of debt repudiation remains a distant one. Still, if I were in the market for US government bonds, I’d want at least another percentage point on the interest rate after reading Safire.
* ‘material breach’ is supposed to provide an automatic trigger for a US invasion. The US resolution is highly ambiguous, however. It’s not clear whether the trigger requires Iraqi noncompliance with weapons inspections and, if so, whether the inspectors have to certify such noncompliance or whether the US can make a unilateral determination.

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