Debt crisis

A debt crisis occurs when a nation-state is unable to meet its sovereign debt service obligations. A variety of operational definitions in the empirical literature relate in one way or another to indicators of debt-servicing difficulties: missed interest payments, missed principal payments, widening sovereign debt interest rate spreads and the like (see Pescatori and Sy, 2004). Notably, the label of a "debt crisis" is often affixed before any outright debt default occurs, and, as such, the crisis represents as much a crisis of confidence as any threat of actual default.

Although debt crises have a long history (see Eichengreen and Lindert, 1989), it was the experience of several global South countries in the 1980s that captured the attention of the contemporary international financial community. Informed by neoclassical eco- nomic theory, analyses of these crises assumed macroeconomic imbalances were due to inadequate market discipline creating fiscal deficits that caused the crises. The con- sensus opinion on a resolution saw country after country forced to "liberalize", "pri- vatize", "deregulate", and generally cut public spending as conditions of the bailout packages. The result was "a dramatic global episode that had profound and lasting effects on international financial flow patterns [. . .] and developing country economic policy" (Barrett, 1999, p. 185). The considerable human costs, social dislocation and rising income inequality resulting from the forced structural adjustments compounded the considerable resource costs of the crises to people and nations least able to pay (see George, 1989).

In the midst of a more recent wave of crises, one finds in mainstream literature dis- cussions of multiple crises and a growing acknowledgment of the complex interactions that render it difficult to pinpoint a single causal process. "[T]he sovereign debt crisis is deeply intertwined with the banking crisis and macroeconomic imbalances that afflict the euro area [. . .]. Even if the crisis was not originally fiscal in nature, it is now a full-blown sovereign debt crisis" (Lane, 2012, p. 50).

Where a nation's ability to service its debt depends on income available to make interest payments, rising domestic debt-to-Gross-Domestic-Product (GDP) ratios beg the ques- tion: how much debt is too much? Near the end of 2012, with Greece's public debt having reached approximately 140 per cent of GDP, a crisis emerged that continues (at the time of writing) to wreak havoc with the local economy. Japan, by contrast, has thus far avoided the panic of a crisis despite the fact that its gross debt is fast approaching 240 per cent of the country's GDP. Where true uncertainty in the Keynesian sense shapes the economic environment, future profitability from a given investment is unknowable. In an economic environment of the type envisioned by Keynes (1936), we lack the ability to assess the appropriateness of any level of debt incurred (see Spotton Visano, 2006) and must look beyond economic activity to understand fully the threat to confidence in a nation's ability to meet its debt-service obligations.

As with all financial crises, streams of income in excess of contemporaneous changes in debt-service costs define a debtor's margin of safety. Minsky (1986) explains a declin- ing margin of safety over time with recourse to financing incentives that encourage and enable shorter-term borrowing for longer-term investments. Upward pressure on debt- service costs causes an increasing fragility that erodes the safety margin and eventually culminates in the threat of a default. The recent trends in "financialization" (that is, the increased dominance of financial securities in the tradeable value of commodities) and its extension to "securitization" (the consolidation of financial debt into bundled mar- ketable instruments) are developments that have altered the structure of the financial economy and increased the speed with which a Minsky-like financial fragility emerges (see Girón and Chapoy, 2012).

Proponents of neoclassical explanations of a debt crisis advocate for preventative poli- cies that focus on regaining macroeconomic balance primarily through market discipline (see Williamson, 2004-05). Post-Keynesians consider macroeconomic imbalances as the outcome, rather than the cause, of a financial fragility exacerbated by recent trends in the restructuring of finance capitalism. Davidson (2004-05) criticizes the neoclassical prescriptions, arguing that by creating perverse incentives these prescriptions set nation against nation. Davidson and other post-Keynesians tend to favour preventive policies that aim to stabilize global effective demand and curtail speculative financial capital flows.

See also:

Financial crisis; Financial instability; Financialization; Minsky, Hyman Philip.