Bankrupt countries

Countries shouldn’t go bankrupt. But they do – Iceland suffered a near bankruptcy, Pakistan is running around with a begging bowl, India did the same in 1991, and lots of countries did it in the 1997-98 emerging markets and “tiger” economies crisis. How did this happen?

Every country has its own fiat currency. Some allow it to float freely, and allow conversion both on the current account as well as the capital account; others use their central banks to fix the rate vis-a-vis other currencies – a direct peg, or a range. Money moves in and out of countries in various ways – payments for imports and exports, investments – short term and long term, remittances, loans and so on. And most of these transactions take place between individuals, corporations and banks; except when governments borrow money on their own account. Now, those countries that still exercise control over their currency markets find that if they keep their currency low vis-a-vis the dollar (or the other major currencies, mainly the dollar though), their exports are cheaper compared to other competing countries. So their central banks will buy dollars from the market (from exporters or anyone else who has dollars and wants to sell it) thereby keeping their currency low. Others prefer a stronger currency – they will do the opposite – shore up their currency. This is how they peg their currency against another. But this is a game till it blows up in their face, either way – they will have to either maintain huge foreign currency reserves trying to keep their currency low (flooding the market with fiat currency and then having to resort to other measures to suck it out), or bankrupt themselves trying to peg it at unrealistic exchange rates (throwing dollars at the market till reserves extinguish); its simply a matter of time. And the now-defunct Bretton Woods or any other fancy system won’t help it one bit.

When countries consistently run up current account deficits, and don’t have others sources of foreign currency inflows, they find themselves in a precarious situation when it comes to repayment of loans in foreign currency; businesses in the country won’t be able to pay back their loans or import bills. Under laissez-faire capitalist systems, this wouldn’t be a problem because businesses and countries will know that they cannot spend beyond their means and can’t trade in what others don’t want. But in a world used to quick fix solutions and fiat money, government intervention in the economy as well as currency markets wrecks havoc on market signaling mechanisms, and “problems” that would other wise be considered normal becomes monsters. Such fiddling has huge implications for the US which is the beneficiary of mainly Chinese and S.E.Asian policies, and the pricing of Middle Eastern oil in dollars.

Every major country in the world, as also the so called “sovereign wealth funds” (how can countries go bankrupt? how can countries “own” wealth?) has money invested in US treasuries and stock markets, and the dollar being the currency of reserve, the US does not have to maintain such reserves. But a day might come when the sheikhs decide that they would rather receive payment in euros or the yuan, and a day will come when the Chinese stop working for everyone else and start enjoying the benefits of their labor. Money will then exit from the US, and with the US running huge trade deficits and having a huge debt burden, things could get pretty bad. The utter nonsense that Paulson and Bernanke have indulged in in trying to live another day is a sign of ominous times to come. As Liam Halligan says, “Yes siree, the mighty US government could default.” I am no economist, but its surely in the realm of possibility – if the current crisis does not set the ball rolling, the reasons I mentioned should; a laissez-faire belt tightening is the only solution.

Countries shouldn’t go bankrupt; its a stupid concept that has been realized thanks to the fiddlers in government.

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