How "Original Sin" was Overcome: The Evolution of External Debt Denominated in Domestic Currencies in the United States and the British Dominions

Abstract

Many emerging countries today have difficulty in borrowing domestically long-term and are unable to borrow abroad (both sovereign and corporate debt) in terms of their own currencies.Consequently they need to borrow in dollars to access foreign capital markets.This problem of ""Original Sin"" also plagued many of the emerging countries in the previous age of financial globalization, the half century preceding World War I.This paper examines the issue of "Original Sin" from a historical perspective.We provide answers to a number of questions including: what factors determine membership in the club of countries who are free from Original Sin?What can countries do to enter this club?Is entry permanent or transitory?Under what circumstances does entry occur n in the face of big shocks like World War I or as part of a gradual evolution?Did countries free themselves from one component of Original Sin (e.g., by lengthening domestic debt maturity) but not the other?Finally, does the fact a country has little external debt in terms of its own currency necessarily make it vulnerable to crises because of a currency mismatch?This paper attempts to provide some answers to these questions by conducting an historical case study for a group of countries that successfully entered the club and had largely overcome the problem of Original Sin by the third quarter of the twentieth century.The group consists of several former colonies of Great Britain: the United States, Canada, Australia, New Zealand and South Africa.We trace out their debt history relating the currency to the place of issue, exploring the residency of those holding local and foreign currency debt and looking at the maturity of domestic debt in the nineteenth and twentieth centuries.We find that sound fiscal institutions, high credibility of the monetary regime and good financial development are not sufficient to completely break free from Original Sin.Conversely, poor performance in these policy realms is not, for the most part, a necessary condition for Original Sin.The factor we emphasize for the common movements across the five countries is the role of shocks such as wars, massive economic disruption and the emergence of global markets.The differences in evolution between the U.S. and the Dominions we attribute to differences in size, the traits of a key currency, which the U.S. possessed and the others did not, and to membership in the British Empire.The important role of major shocks suggests that the establishment of a bond market involved significant start-up costs, while the role of scale suggests that network externalities and liquidity were pivotal in the existence of overseas markets in domestic currency debt.

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