Countries that owe a lot of debt to themselves, such as Japan, have a range of options to deal with the problem. They can buy the debt up with created money, cancel it, refinance it at ever-lower rates or tax themselves more to meet the interest payments. Their debt is in a currency the state controls and creates as necessary.
However countries that owe a lot of debt to foreigners in foreign currencies have fewer options. The country needs to buy enough of the foreign currency to pay the interest and meet the capital repayments. If foreign investors lose confidence in the country or its government, the value of their domestic currency falls, making it ever dearer to service the foreign currency debts. In these circumstances printing more of the home currency may help, or it could undermine confidence in that currency further.
This is why the worst financial and economic crises usually occur in countries running a large balance of payments deficit and facing the need to meet substantial foreign currency debt payments. The Latin American countries have often been under scrutiny for these problems, with the occasional state bankruptcy terminating a struggle to meet the payments. Runs on a currency force higher interest rates, and require policies designed to curb demand to cut the purchases of imports. As Brazil has discovered again, you end up with high inflation, high interest rates and a recession.
The world economy today remains dominated by a balance of payments surpluses and deficits. China, the Euro area and Japan remain in persistent surplus. This takes the pressure off to some extent when they run up large domestic debts.
The USA, the UK and much of Latin America remain in substantial deficit. Foreign debts are not a big problem for the USA or the UK governments as they mainly borrow at home. Their large liquid markets continue to attract substantial inflows of foreign capital to finance the running balance of payments deficits. Overseas investors make large asset purchases and lend to the private sector. These inflows of money match the outflows of cash to buy more goods and services from abroad.
The Brazilian current account deficit has proved more painful, and is part of the reason the Brazilian economy has gone into a deep recession as the authorities battle the twin state and balance of payments deficits. Venezuela is an extreme case, with a balance of payments deficit being part of a general economic crisis resulting from too much money chasing too few goods, resulting in very high inflation.
The World Bank figures for 2015 show China in surplus to the tune of $330bn, and the Euro area also in surplus to the same extent. Within that Germany is the main source of the export success, contributing $285bn. Japan produced a $135bn surplus last year. By far and away the largest deficit country was the USA, at $463bn.
In recent months the yen and the Euro have performed a bit better, despite the large quantities of these currencies being created by their Central banks. One of the reasons is the large balance of payments surplus these countries run, providing them with constant flows of foreign currency in return for goods and services sold, which serves to underpin the performance of their domestic currencies. While it should normally be the case that printing more money leads to it being less valuable in world currency markets, a state can get away with it for a while if it is running a good payments surplus.
John Redwood is Charles Stanley’s Chief Global Strategist.