What happens when a country cannot or will not pay its sovereign debt (government bonds and other obligations of the State) or even the interest on it? Similarly, what happens if a government pays off its debts with its own worthless currency, despite the fact that the debt is denominated in that of another country?
The first thing that happens, obviously, is that the government of the country that defaults on its debt must find other sources of financing. Since that is highly unlikely, the government either declares bankruptcy, or forces its central bank to purchase its debt, creating more worthless currency to do so. This triggers a high rate of inflation and if the currency is deemed utterly worthless even by the citizens of the country, can kick off “hyperinflation.”
Hyperinflation is not merely high or even extraordinarily high inflation. In ordinary inflation, the price level reacts to the increase in the money supply that is not backed by assets. As the amount of currency increases, the price level rises, sometimes to phenomenal heights.
In hyperinflation, the price level rises exponentially faster than the money supply. From not being able to raise prices fast enough to keep up with expansion of the money supply, the situation changes to where money cannot be created fast enough to keep up with the rise in the price level. Economic transactions either shift to using other forms of money, or don’t take place at all.
Stopping hyperinflation requires an immediate shift to an asset-backed reserve currency, preferably consisting of private sector assets . . . but that’s a story for another day. What we’re looking at in this posting is the possibility that Russia will begin defaulting on its sovereign debt as early as today. That means that Russia will not pay the interest or principal on the debt when it falls due, or pays it in something other than the currency specified in the debt instrument, e.g., worthless Russian Rubles instead of the contractual U.S. Dollars or Euros.
Specifically, the Russian government is due to pay U.S. $117 million in interest on two of its dollar-denominated bonds. By the time this posting is published, the issue may already have been decided, but we’re guessing that Russia will not make the payment in U.S. Dollars. Strictly speaking, Russia has a month of grace, but that’s only a technicality. The country won’t be in any better financial shape in thirty days and is likely to be much worse.
To all intents and purposes, Russia is setting itself up to enter the record books as the only country in the last couple of centuries to default twice internationally. The first time was following the Bolshevik Revolution in 1917 when the new government refused to honor Tzarist bonds. These were finally redeemed about thirty or so years ago for kopeks on the ruble, but it took decades to do so, and was more of a backhanded apology to give the world confidence in the Russian financial system and ability to honor its obligations than a meaningful act.
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| Liberation, Russian Style |
Russia won’t have any trouble breaking its word, given that it guaranteed Ukrainian sovereignty at the dissolution of the Soviet Union then goosestepped into Crimea and started funding Russian-created separatist regions in 2014 — after pulling the same stunt in Georgia. Russia has become so tied in to the global economy, however, that what was hardly a blip on the radar in 1917 (yes, we know radar didn’t exist then, it’s a figure of speech) can cause massive upheaval today, especially in light of the global reliance on bankrupt (in more ways than one) Keynesian economic and monetary theory.
You see, in Keynesian theory — taken directly from the work of the socialist Georg Friedrich Knapp — the whole of the money supply must consist of government bills of credit (government debt) backed by the general wealth of the economy. That this effectively vests the government with de facto ownership of everything (and everyone) in a country is something that the so-called experts carefully avoid considering or discussing.
If a government can’t meet its foreign obligations, the whole thing can go belly-up very quickly. Domestically, the pyramid scheme of Keynesian economics can go on as long as the politicians and economists can fool the people (e.g., “The national debt is nothing to worry about, as it is a debt we owe ourselves, so we don’t have to pay it.”). It’s a way that politicians can do pretty much what they want until people catch on. As Henry C. Adams said,
The great danger to self-government in the United States lies in municipal corruption, and municipal corruption is in large measure traceable to the manner in which cities have used their credit. For American readers, this reference to local government is a pertinent illustration of a most dangerous political tendency of deficit financiering. [Public Debts, An Essay in the Science of Finance. New York: D. Appleton and Company, 1898, p. 25.]
To this, of course, we can add the way that the federal government has used its credit by emitting bills of credit it is not constitutionally permitted to do. Neither can the states, but none of them are trying to do it (although they’d certain like to). We can also add the problem of international borrowing. As Adams said,
The tendency of foreign borrowing is in the same direction as that of domestic borrowing. As the latter obstructs the efficiency of constitutional methods, so the former tends to destroy the full autonomy of weak states. The granting of foreign credit is a first step toward the establishment of an aggressive foreign policy, and, under certain conditions, leads inevitably to conquest and occupation. (Ibid.)
Of course, none of this makes it absolutely certain that Russia will find it necessary to admit what was painfully obvious from the second day of the invasion (apart from the treacherous invasion of a neighboring country whose sovereignty Russia guaranteed . . . and then annexed parts) — that the invasion was a military, political, moral, and economic mistake of cosmic proportions. Nevertheless, the money question might just make it too painful even for a megalomaniac like Putin to continue.
The problem is that, unlike some would-be conquerors, such as Napoleon and Hitler, Putin doesn’t appreciate the significance of a sound economy if one wants to rule the world. He also doesn’t understand money, obviously having egregious misconceptions about it, and thinking that debt-backed currency is a commodity and inherently valuable instead of a symbol of value. The combination can be fatal, as the outcome of a default may easily reveal.
And this doesn’t even bring in the problems associated with what can only be called grossly incompetent military strategy. Military experts are starting to claim that Russia cannot keep up the present level of aggression for longer than another week or so. We’re not military experts (except down to the beginning of the eighteenth century), but you can’t carry on a military campaign if you run out of time, men, and ammunition, and Russia has expended all three with a lavish hand.
Obviously we don’t know how all this will end, but according to a few experts in both the military and the financial fields, Russia may soon have to admit defeat in a completely unnecessary war that they began.
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