Research Topics

Originally issued as EDI Working Paper No. 17, March 2024
This paper challenges the prevailing view in the sovereign debt literature by arguing that sovereign debt markets, in many respects, behave similarly to other credit markets. These markets are hierarchical rather than flat, inherently hybrid in nature, blending elements of public order and private markets, and regularly suffer from liquidity stress. Therefore, sovereigns, similarly to private actors in the market, are subject to liquidity stress and insolvency crises in a way that is integral to the global financial architecture. Critically, the legal and institutional design of the international monetary system exacerbates this stress. Structural asymmetries, notably the uneven distribution of monetary power, lead to liquidity stress being more pronounced in the periphery than at the apex or core of the system, rendering the former inherently more vulnerable to sovereign debt crises.

The paper argues that such considerations should assume a central role in global policy discussions concerning the most appropriate mechanisms for addressing sovereign debt crises. It advocates for a reformed global financial architecture, emphasizing the necessity of a legally binding framework for sovereign debt restructuring that draws upon principles of corporate restructuring law, with the UK Companies Act 2006 (CA 2006) providing relevant analogies. This approach aims to ensure timely, equitable, and efficient restructuring processes, thereby confronting the challenges posed by the current ad hoc and often inequitable sovereign debt restructuring processes.

Against the background of an ongoing trade dispute between the United States and China, Senior Scholar Jan Kregel analyzes the potential for achieving international adjustment without producing a negative impact on national and global growth. Once the structure of trade in the current international system is understood (with its global production chains and large imbalances financed by international borrowing and lending), it is clear that national strategies focused on tariff adjustment to reduce bilateral imbalances will not succeed. This understanding of the evolution of the structure of trade and international finance should also inform our view of how to design a new international financial system capable of dealing with increasingly large international trade imbalances.

The post-1945 mode of global integration has outlived its early promise. It has become exploitative rather than supportive of capital investment, public infrastructure, and living standards.

In the sphere of trade, countries need to rebuild their self-sufficiency in food grains and other basic needs. In the financial sphere, the ability of banks to create credit (loans) at almost no cost, with only a few strokes on their computer keyboards, has led North America and Europe to become debt ridden—a contagion that now threatens to move into Brazil and other BRIC countries as banks seek to finance buyouts and lend against these countries' natural resources, real estate, basic infrastructure, and industry. Speculators, arbitrageurs, and financial institutions using "free money" see these economies as easy pickings. But by obliging countries to defend themselves financially, they and their predatory credit creation are helping to bring the era of free capital movements to an end.

Does Brazil really need inflows of foreign credit for domestic spending when it can create this at home? Foreign lending ends up in its central bank, which invests its reserves in US Treasury and euro bonds that yield low returns, and whose international value is likely to decline against the BRIC currencies. Accepting credit and buyout "capital inflows" from the North thus provides a "free lunch" for key-currency issuers of dollars and euros, but it does not significantly help local economies.