Not far from the London offices of the Financial Times was the Marshalsea prison where debtors used to be sent. In the 18th century, more than half of London’s prisoners were incarcerated for the undischarged debt. The moral hazard Taliban of the day insisted that such harsh penalties were necessary. Then, in 1869, imprisonment for debt was abolished and bankruptcy introduced. Both economy and society survived.
Things sometimes go wrong. Sometimes this is due to bad luck and sometimes to irresponsibility. But society needs a way to allow people to start over again. This is why we have bankruptcy. Indeed, we allow the most important private actors in our economies – companies – to enjoy limited liability. This lets shareholders walk away from their companies’ debts unscathed. That idea, too, was condemned as a licence to irresponsibility when introduced. Limited liability does bring problems, notably in highly-leveraged businesses (such as banking). The ease with which US corporations can walk away from their creditors is breathtaking. But this is better than unlimited liability.
A similar logic applies to countries. Sometimes their governments borrow more than they turn out to be able to afford. If they have borrowed in domestic currency, they can inflate their debt away. But if they have borrowed in foreign currency, that possibility disappears. Usually, it is countries with a history of fiscal irresponsibility that find themselves obliged to borrow in foreign currencies. The eurozone has put its members in the same position: for each government, the euro is close to being a foreign currency. When the costs of servicing such debts become too high, then restructuring – default – becomes necessary. As Carmen Reinhart and Kenneth Rogoff of Harvard University showed in This Time is Different, this is an old story.