NCPA - National Center for Policy Analysis


February 17, 2010

When is sovereign debt a problem and when does it become a crisis?  Focusing on countries only, too much debt becomes a crisis if the debt is payable in a currency other than the debtor's currency, or if the debtor has no central bank to purchase its debt, i.e. monetize it, says Bob McTeer, a Distinguished Fellow with the National Center for Policy Analysis and a former President and CEO of the Federal Reserve Bank of Dallas. 

U.S. debt is a problem, but not a crisis, says McTeer: 

  • If worse comes to worse, the Treasury (with the help of Congress) could prevail on the Federal Reserve to buy its debt at prices more favorable than those demanded by foreign creditors.
  • If not sterilized, thus neutralizing the impact of the purchases on the money supply, the Fed would be monetizing the debt and a pickup in inflation would be the likely outcome.
  • Indeed, that is what people mean when they refer to "inflating your way out of debt." 

A developing country that cannot issue debt in its own currency, but must issue it in another currency, say U.S. dollars, must earn the dollars necessary to service and redeem the debt through foreign trade (or perhaps temporarily through foreign borrowing to roll the debt over).  It does not have the luxury of borrowing from its own central bank to service and redeem the debt, explains McTeer: 

  • Since Greece is one of 16 members of the Euro zone, its position is very much like a state in the United States.
  • The European Central Bank is its central bank, but Greece cannot force it to monetize its debt.
  • Likewise, California shares its central bank with 49 other states and cannot force it to buy and monetize its debt.
  • Just as Greece has to earn the Euros it needs, so must California earn the dollars it needs. 

Of course, California is a larger percentage of the dollar zone than Greece is of the Euro-zone and is more likely, eventually, to be treated as too big to fail, not by its central bank, but by its federal government.  Since the dollar zone has been around a long time and states don't have the option of dropping out, California will likely have less leverage with its federal government than Greece has with the European Community, says McTeer. 

Source: Bob McTeer, "Sovereign Debt: Greece and California," Taxes and Budget Blog/National Center for Policy Analysis, February 15, 2010. 

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