From Marketwatch today, “Morgan Stanley warns on sovereign defaults”:
“Outright sovereign default in large advanced economies remains an extremely unlikely outcome,” they said. But bondholders could suffer losses from forms of “financial oppression,” such as repaying debt with devalued currency, the analysts warned.
Then there is the increased possibility that governments will resort to other, less-conventional means of deficit-reduction. As Adam Smith observed long ago in The Wealth of Nations, “when national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid.” Smith went on to explain that “the liberation of the public revenue, if it has ever been brought about all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”
By “pretended payment,” Smith meant governments would seek to escape their debts by inflating the currency. In this way, governments could legally deny creditors what they are due in real terms, while simultaneously avoiding formal bankruptcy.
Of course, whenever a government resorts to inflation to diminish its debts, it has, for all intents and purposes, effectively acknowledged its insolvency. But such actions, as Smith noted, also constitute gross injustices against numerous innocents. Those who have been frugal and industrious suddenly find the value of their savings and capital arbitrarily reduced because of others’ financial irresponsibility. This also reduces the incentives for people to save and invest. For why should anyone bother to do so if they cannot be reasonably sure that the worth of their savings will not be suddenly diluted by government fiat?