The sovereign, its creditors and the law

By Roberto Bissio | The Group of 77 and China tabled at the United Nations a draft resolution to start negotiating a multilateral legal framework for the sovereign debt restructuring processes.

To meet their ends, sovereigns borrow. In the not so distant past sovereign debt financed military adventures or profligate lifestyles of monarchs and their courts. In the contemporary world the first obligation of States is to respect, promote and protect human rights, and therefore it is the need for a development that maximizes welfare what justifies the sovereign debt.

There is a huge ethical and political progress between the absolutist State and one based on the democratically organized sovereignty of the people. However, when the sovereign is struggling to pay its debts, the world remains a lawless territory now as before.

In 1307, Philip IV of France avoided bankruptcy by accusing his creditors, the Knights Templar, of heresy and sodomy and sending them to the stake. If, however, the force was on the side of creditors, they did not hesitate to use it against the sovereign debtor at fault (default). In 1902 the navies of Britain, Germany and Italy blocked the ports of Venezuela to collect their debt in arrears. Dozens died as a result of this exercise in “gunboat diplomacy” and the European powers took control of Venezuelan customs until 1930.

Latin American popular reaction against this abuse was enormous but only one government showed solidarity with the victims and Argentine Foreign Minister Luis Maria Drago issued in December 29, 1902 a document outlining what is now known as the Drago Doctrine: violent recovery of a debt is illegal. This is obviously most helpful for small debtor States, defending them against of the arbitrary powers that frequently act as judge, jury and executioner.

Apart from banning acts of war against debtors, nothing has been done since then to solve with legitimacy and impartiality the disputes between creditors and sovereign debtors.

In 1956, the Argentine government could not pay short-term debts contracted by the government of General Pedro Aramburu after overthrowing Juan Peron the year before. Argentina accepted the invitation of France to negotiate a settlement with the creditor countries and thus was born the Paris Club, in which sovereign creditors negotiate with sovereign debtors the rescheduling of official debts. It is an informal and partial mechanism in which each small debtor country must sit down and negotiate in very difficult conditions with the governments of nineteen powerful countries (the United States, most of Western Europe, Canada, Japan, Israel and Russia). After almost sixty years, the Club has renegotiated four hundred thirty times the official debt of ninety creditor countries, for a total of 583 billion dollars.

But in the last two decades sovereign debt has changed, as governments no longer borrow from other governments but sell bonuses to national and international private investors. A State lending to another has the assurance that it will recover its money, if not by gunboats, by the collective pressure of the Club de Paris. Who will defend the individual investor? Market logic is implacable. If the debtor is perceived as risky, the bond buyer will demand high interest rates. The countries that most need the money pay more dearly for it.

To lower risk rates, countries issue bonds in "hard" currencies (dollars, euros or yen), they use large international banks as intermediaries and eventually resign legal sovereignty, establishing the laws and courts of New York, London or Tokyo to deal in any dispute with creditors. Thus, the banks and the financial systems of these cities thrive at the expense of the needs of developing countries.

Sovereign bonds were first issued in the sixteenth century by Philip II, who made history as the greatest king of Spain, despite three defaults (and subsequent restructuring) of his debt. The issuing of bonds to finance development grew explosively in the last two decades. A total of fifty-five trillion dollars in sovereign bonds is now circulating, a hundred times more than the entire government to government debt renegotiated by the Paris Club in its history.

But all this financial architecture depends ultimately on a bunch of judges such as Thomas Griesa, from New York, of whom the New York Times said that he "seems not to have understood" the functioning of the bonds market under his jurisdiction and whose decision in favor of so-called “vulture funds” and against good faith investors  "can hardly inspire confidence in the American legal system."

The International Capital Market Association (ICMA), which groups the intermediaries of sovereign bonds, is demanding new rules and the Group of 77 and China just tabled at the United Nations a draft resolution to start negotiating “a multilateral legal framework establishing a legal regulatory framework for the sovereign debt restructuring processes in order to increase efficiency, stability and predictability of the international financial system."

The General Assembly of the UN will vote on this next September 9. The decision can change the history of sovereign debt, which is the financial expression of the world history of inequities.

Roberto Bissio.

* The article is the English version - avaialble on Social Watch website -  of a column originally published by Uno in Lima, Peru.


Photo: Boston Bill/Flickr