Why not default? The political economy of sovereign debt

Abstract

Debt involves an obligation to repay the creditor, principal plus interest. But how does one oblige a sovereign state to honour its debt obligations? While creditors can bring defaulting private borrowers before a court and lay claim to their income and assets in order to compensate for default losses, sovereigns are not so easily summoned. In the absence of a supranational authority to enforce repayment of sovereign debt, and without legal means to seize a sovereign debtor's assets, why don't sovereign borrowers just repudiate their loans and default? Recognizing this hazard, historically creditors have attempted to enforce their claims using armed and naval force via gunboat diplomacy. But even this practice could backfire. In the latter half of the nineteenth century, Napoleon III went to great lengths to coerce Mexico into financial submission. After the nationalist Benito Juarez swept to power and suspended debt payments in 1861, France sent troops and naval fleets for a full-blown invasion of Mexico. Maximilian I was appointed to the Mexican throne. Mexico fought back. Interest payments on the loan soared to the order of 100 per cent of Mexico's national income. The net effect was to further deepen Mexico's resistance to France, whose attempt to enforce creditor claims failed miserably. By the end of the 1860s Napoleon III had withdrawn all contingents from Mexico. Only Maximilian stayed. He was summarily executed. In The Execution of Emperor Maximilian, the nineteenth-century modernist painter Édouard Manet immortalized the salvo of the firing squad after the Emperor dramatically circled his heart and uttered, ‘aim well, Muchachas’.

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