Harold James: Bleed the Foreigner

PRINCETON – Today, the world is threatened with a repeat of the 2008 financial meltdown – but on an even more cataclysmic scale. This time, the epicenter is in Europe, rather than the United States. And this time, the financial mechanisms involved are not highly complex structured financial products, but one of the oldest financial instruments in the world: government bonds.

While governments and central banks race frantically to find a solution, there is a profound psychological dynamic at work that stands in the way of an orderly debt workout: our aversion to recognizing obligations to strangers.

The impulse simply to cut the Gordian knot of debt by defaulting on it is much stronger when creditors are remote and unknown. In 2007-2008, it was homeowners who could not keep up with payments; now it is governments. But, in both cases, the lender was distant and anonymous. American mortgages were no longer held at the local bank, but had been repackaged in esoteric financial instruments and sold around the world; likewise, Greek government debt is in large part owed to foreigners.

Because Spain and France defaulted so much in the early modern period, and because Greece, from the moment of its political birth in 1830, was a chronic or serial defaulter, some assume that national temperament somehow imbues countries with a proclivity to default. But that search for long historical continuity is facile, for it misses one of the key determinants of debt sustainability: the identity of the state’s creditor....