Since 2008 Europe has been mired in a combination of economic depression, financial crisis, and public and private debt overhangs. Greece was the first advanced economy to restructure its debt in more than a generation, and the ongoing depression in Europe’s periphery has already surpassed the economic collapse of the 1930s by some markers. In most advanced economies record private debt overhangs are unwinding only slowly, while the steady upward march in public debts continues largely unabated. As a result, the broad subject of sovereign debt crises and the role of debt write-offs in their resolution is no longer a matter of solely academic interest.
This column adds a historical perspective to the small body of work on sovereign debt relief episodes of recent decades (see, in particular, Arslanalp and Henry 2005, Chauvin and Kraay 2005, Dias et al. 2013, Sturzenegger and Zettelmeyer 2007). In Reinhart and Trebesch (2014) we draw lessons from two main historical episodes of sovereign default and debt relief:
- the well-known emerging market debt crises of recent decades (1980s-2000s), and
- the lesser-known debt crisis and overhang episode of war-related debt in advanced economies of the 1920s and 1930s, which emerged as a result of WWI and its aftermath.
We collect a new dataset on indebtedness, default and relief for both episodes and then study the economic landscape before and after the resolution of the crises.
The magnitudes of debt relief
The findings for the 1930s are particularly revealing: many of today’s advanced economies benefited from large-scale debt relief thanks to their 1934 default on war-related debt owed to the US and UK, the two main creditor governments of the time. The amounts were substantial: in France, Greece, and Italy, the war debt relief accounted for 36%, 43%, and 52% of 1934 GDP respectively. These debts were fully written off and the debt largely forgotten. Table 1 provides an overview on the amounts involved.
Table 1. Unpaid allied wartime and postwar debt owed to the US and the UK: The 1934 summer defaults
Sources: Debt amounts owed to the US are from the Annual Report of the Secretary of the Treasury on the State of the Finances – For Fiscal Year Ended June 30, 1934, pp. 391. Debt figures are given for Nov 15, 1934. We add to this the amount of arrears, i.e. overdue payments under the debt restructuring agreements of the 1920s. Debt amounts owed to the UK are from the Moody's Manual of Investments and Securities Rating Service: Foreign and American Government Securities, 1935, p.1927. Debt figures are given for March 31, 1934, plus arrears. To compute present values (last column) we use the terms shown in the original loan documents, as shown in Moulton and Pasvolsky (1932). We follow their approach and use a 5% annual rate to discount future war debt payments. The amounts of debt outstanding under the broad category of WWI debt includes, especially for Eastern Europe, debts taken on after the war in connection with reconstruction. The breakdown is given for each debtor country in Reinhart and Rogoff (2014).
Exchange rates are from Historical Statistics of the United States and United Nation (1948). The sources for nominal GDP for 1934 are as follows: US and UK from Measuring Worth; France, Historical National Accounts Database (HNAD), 1815-1938 ; Italy, Francese and Pace (2008) 1861-2006; Belgium, 1835-2005, BNB, Center d'études économiques de la KUL; Greece, Kostelenos (2003), 1830-1939; Austria, 1924-1937. Global Financial Data; Finland GDP, Historical National Accounts Database (HNAD), 1860-2001; Portugal: Estadisticas Historicas Do Portugal, 1851-1952; New Zealand: Statistics New Zealand, 1900-1947; Australia: GFD, Haig (2001) 1852-1948;
Note: For a full set of references see Reinhart and Trebesch (2014).
Figure 1a shows that the average magnitudes of debt relief in the 1930s are similar to those in emerging market debt crisis events of recent decades, while Figure 1b provides greater detail on the advanced economy episode of the 1920s-1930s. More specifically, we find that, across 45 debt crisis episodes for which we have sufficient data, debt relief averaged 19% of GDP for advanced economies (1932-1939) and 16% of GDP for emerging markets (1979-2010). The figure includes one domestic debt event in the 1930s: the abrogation of the Gold Clause in the US in 1934.
Figure 1a. Default, restructuring, and debt relief: World War I debt to the US and the UK, 1934, emerging markets, 1978-2010 (debt relief as a percent of GDP)
Sources: Cruces and Trebesch (2013), Reinhart and Rogoff (2009), Reinhart and Trebesch (2014)
Figure 1b. War debt relief of major European countries as a share of GDP in 1934
Notes: Estimates of war debt relief in % of creditor country GDP. Figures are shown for debt owed to the US and to the UK separately. The sources are the same as in Table 1a. The present value estimates use an annual discount rate of 5% and the contractual debt service streams of the original agreements as in Moulton and Pasvolsky (1932).
Parallels in crisis resolution
We also find parallels in the progression and outcomes of the two debt crisis eras. Box 1 provides a thumbnail comparison of three international episodes: the 1920s/1930s, the 1980s/1990s, and post-2007. War debts were the dominant type of indebtedness for many advanced countries in the 1920s, just as were bank loans to developing countries in the 1970s and 1980s.1
Box 1. Selected features of international debt overhang episodes
In the 1920s, much of the international policy discourse focused on the need for debt relief. There were preliminary rescheduling agreements in the early 1920s which postponed war debt repayments to the US and the UK by more than 20 years, but without a reduction in the nominal debt burden. This is very similar to the 1980s, where short-term debt reschedulings (1982-1985) were followed by multi-year rescheduling agreements within the Baker plan (1987-1989), again without nominal write-offs.
Ultimately the war debt overhang was resolved via large-scale debt reduction and the default of 1934, in which 15 European countries as well as Australia and New Zealand suspended their payments to the UK and the US. This explicit debt reduction was a central way to cope with Fisher’s (1933) debt-deflation spiral, thus crucially complementing the devaluation and inflation events. This resembles the 1990s, when the Brady agreements resulted in substantial debt write-offs in 17 developing countries.
The aftermath of debt relief
Figure 2 plots average real per capita GDP (normalised to equal one at time T) around final restructurings (exit from default).2 The average covers 33 of the 35 middle-high income emerging markets (Table 3) for which we have real per capita GDP data.3 The red line shows the comparable average for 12 of the 16 defaulters the 1930s shown in Table 1a plus the US and Germany. While the lines show the level of per capita GDP from both the normalisation to T=1 and the inset box, Figure 2 also summarises the growth performance.
For the 1930s average, 1932 marks the trough in per capita GDP with barely any change through 1934. After 1934 there is a sharp rebound (cumulative growth is 16% from T to T+4) following a prolonged collapse of 7%. Rebound notwithstanding, it takes six years to recoup the income level recorded in T-4 (as we will show, it takes even longer to surpass the prior economic peak in per capita GDP, which usually predated T-4 and corresponds to 1930). The emerging market countries show a flat per capita GDP path while in the default spell (through T) but a substantial pick up thereafter.
Figure 2. Real per capita GDP around final restructurings (exit from default) in middle-high income emerging markets, 1978-2010 and selected 1934 sovereign default episodes (mostly on World War I debt to US)
8-year window around credit event, level of real per capita GDP at T=1
Sources: IMF World Economic Outlook, Maddison Database, Reinhart and Rogoff, (2009 and 2013) Total Economy Database and authors’ calculations. War debt defaults on debts to the US.
The general picture that emerges is that, once the restructuring is completed decisively, economic conditions improve in terms of growth, debt servicing burdens, debt sustainability and international capital market access. Both the advanced economy and emerging market samples provide evidence in this regard.
The critical modifier is ‘completed decisively’. Ex post it is straightforward to date the deal that ends the debt crisis spell. Ex-ante it is difficult to ascertain whether a restructuring proposal will deliver that decisive outcome (given that the debt sustainability calculus is crucially driven by assumptions of future growth and how quickly risk premia decline).
These observations are not meant to imply that the restructuring or default process is not fraught with a variety of risks including reputational issues; it is meant to suggest that the ‘punishment’ is neither permanent nor even persistent. In effect, exit from default has in a few cases been followed by a renewed surge in borrowing culminating in a new debt crisis within a decade of the exit of the previous crisis.
The 2010s: Another lost decade?
Much of the 1920s and 1930s were ‘lost decades’ for European countries – similar to the 1980s in Latin America and Africa. In both eras there were countless conferences and international summits on how to solve the debt problem of the time. In the end, debt write downs and defaults were delayed but not prevented. It has already been seven years since the onset of the subprime crisis in the summer of 2007. Perhaps past episodes can offer insights into the current predicament, as the debt overhang of the 2010s still awaits resolution.
Arslanalp, S and P Henry (2005) "Is Debt Relief Efficient?" Journal of Finance, Vol. 60 No. 2, 1017-1051.
Chauvin, N D and A Kraay (2005) “What Has 100 Billion Dollars Worth of Debt Relief Done for Low-Income Countries?” Washington, DC, World Bank, September.
Dias, D A, C Richmond and M L J Wright (2013) “In for a Penny, In for a 100 Billion Pounds: Quantifying the Welfare Benefits from Debt Forgiveness”, mimeo.
Reinhart, C M and C Trebesch (2014) “A Distant Mirror of Debt, Default, and Relief”, CEPR Discussion Paper 10195, October.
Sturzenegger, F and J Zettelmeyer (2007) “Creditors Losses versus Debt Relief: Results from a Decade of Sovereign Debt Crises.” Journal of the European Economic Association, Vol. 5 No. 2-3, 343–351.
1 Ahamed (2010) often harks back to the war debt overhang theme.
2 See Tomz and Wright (2007) for a long-run study on the link between sovereign default and output.
3 The data comes from Maddison http://www.ggdc.net/maddison/ for pre-1950 and the Total Economy Database (TED) subsequently.