Miss Jane offers advice to Italy

The Reinhart-Rogoff paper on the history of debt crises has been boiled down to a self-fulfilling bond-vigilante creed that countries with a debt-to-GDP ratio of over 100% (like Italy and Greece today) have entered a zone of trouble.

Maybe so. But how then did Britain in 1815 manage a postwar debt-to-GDP ratio that is now estimated at anything from 260% to 290%?

Contemporaries did not of course have any number for GDP, hence the uncertainty in the retrospective ratio. But they did know exactly how large the nominal debt was – £854m – and how much the annual interest burden was – almost 60% of the peacetime budget. SFIK they managed it perfectly well. There were regular banking crises and panics in the following half-century, but the debt interest was paid like clockwork, and default was not on the agenda. Since the government ran a primary budget surplus, and kept out of big new wars and new borrowing, so the economic growth of Britain. industrial hegemon of the world, made the debt less and less of a problem – until 1914.


How come?
We can rule out genius as an explanation. The Chancellor of the Exchequer from 1815-22, Nicholas Vansittart, First Baron Bexley, was regarded as a duffer by Brougham, Huskisson and Ricardo, the sharpest financial brains in the Commons. He just muddled through.

There were several factors, some not reproducible or desirable.

1. Ruthless plutocracy. Lord Liverpool´s government was very reactionary. Its one social aim was to preserve the rule of the propertied against the unwashed (with no public water supply) and illiterate (with no public schooling) masses. It ran the ultimate night-watchman state of libertarian dreams: Britain had the sketchiest of police forces, let alone a health or education system. The Elizabethan Poor Law made the provision of punitive workhouses to prevent starvation a local responsibility. To maintain this Utopia Liverpool´s government was prepared to cut down demonstrators with cavalry sabres (the Peterloo Massacre of 1819 in Manchester). So it had 100% credibility in the bond market.

The RBC does not actually commend this model. Plutocracy is not a necessary condition for sustaining very high debt levels: it doesn´t apply to Britain in 1918 (175%) or 1945 (250%). But European elites are following the idea, installing banker-led governments in Greece and Italy. There is enough democracy left in both countries to make the enterprise very chancy. And modern banker austerity requires taking away rights and services the poor thought they had won, which wasn´t a problem for Lord Liverpool as he hadn´t conceded any in the first place.

2. Lend to yourself. British debt in 1815 was held by rich Britons and paid by taxes on rich Britons. The debtors and taxpayers were not identifiably distinct groups, and straddled the Whig-Tory political divide. Default is poltically attractive in two circumstances: class war (Russia in 1917) and when debt is massively held by foreigners (Argentina, every time). Another point against the moribund Washington consensus for free capital movements.

3. Borrow long. The crisis for Italy, which runs a primary surplus, has been triggered by having to roll over its debt: €300 bn out of €1.9 trn next year. This is 16% of the total, suggesting an average maturity of less than 7 years. Anti-Napoleonic Britain issued consols – undated, perpetual bonds. The rollover problem didn´t exist; the only real issue was servicing the debt interest. Vansittart wanted to retire debt with a sinking fund, following Pitt, but could not secure support for running a gross budget surplus. His successors in 1914 and 1939 issued undated War Loan bonds. The flatter the maturity profile of the national debt, the less vulnerable it leaves you to bond market vigilantes.

How did Britain make this fortunate choice? Expert input welcome. My guess is that the paradigm form of wealth was land, an eternal asset yielding an indefinite stream of rents. The ideal government bond was the closest substitute for land: a perpetual one. The purchasers were very interested to secure their own and their childrens´ social status by an assured income, and hardly at all in liquidity. Jane Austen´s wealthy heroes are introduced with their incomes, not their assets:

Colin Firth as Mr. Darcy

Mr Bingley: ¨A single man of large fortune; four or five thousand a year.¨

Mr. Darcy: ¨his friend soon drew the attention of the room by his fine, tall person, handsome features, noble mien; and the report which was in general circulation within five minutes after his entrance, of his having ten thousand a year.¨

As BrItain´s economy shifted to trade and industry, liquidity became more important. A life insurance company for instance would not like consols, with their variable capital value, and would prefer a spectrum of fixed-dated bonds matching its liabilities. So modern finance has moved away from consols: perhaps too far.

So Jane Austen´s advice to Signores Draghi and Monti could be to convert a lot of this volatile short-term Italian debt into undated bonds. Today I suspect they would have to be inflation-proofed: the coupon is just the inflation rate plus x, where x is near zero. By definition, the ECB cannot run out of euros to meet the payments.

As a gunner in Kipling´s Western Front story The Janeites puts it:

Brethren, there’s no one to touch Jane when you’re in a tight place. Gawd bless ’er, whoever she was.


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