Sovereign Default Risk

George Magnus is worried about the possibility of sovereign defaults among OECD countries. He says that “[c]oncerted fiscal restraint could trigger another recession,” which sounds to me like an argument for avoiding concerted fiscal restraint. But he says “the lack of it could end up in bigger default risks.” This is obviously true. Concerted restraint would almost by definition reduce default risks. Then again, it could also trigger another recession. That seems like a high price to pay to me. But Magnus seems to feel that by definition anything that lowers the risk of a default is the correct option, even though by his own admission the market price of default risk is very low right now:

At the moment, higher spreads on sovereign bonds and credit default swap rates do not provide convincing evidence of an imminent default crisis, per se. Japan’s public debt has already risen above 200 per cent of GDP, but the government can borrow for 10 years at 1.4 per cent, while Australia’s government debt is about 25 per cent of GDP, but it pays over 5.5 per cent. Other rich countries with varying debt ratios all pay roughly 3.5–4 per cent. However, the status quo is not sustainable.

If I were the government of Japan and people were offering to lend me money for ten years at a 1.4 percent interest rate, I wouldn’t be thinking about austerity, I’d be thinking about what useful investments could I make to seize advantage of this attractive opportunity. Australia’s obviously in a different situation so it makes sense for them to respond accordingly.

Now I suppose there’s a real question here as to what it is that purchasers of bonds issued by Japan think they’re doing. Certainly I wonder. And one might say the same about the United States where the outlook seems pretty grim. But it’s not the job of sovereign states to arrange their fiscal and monetary policies so as to make past decisions made by private investors turn out to look wise down the road. If the volume of deficit spending is driving up interest rates and crowding out private investment, then that’s a problem and deficits need to be lower. But if there isn’t a problem, then it seems to me that it makes more sense to look out the window at 10 percent unemployment and worry about that problem.