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  • Print publication year: 2016
  • Online publication date: May 2016

4 - Pricing Sovereign Debts

from PART I - THE GLORIOUS REVOLUTION AND THE ENGLISH STATE

Summary

Sovereign debts are a subspecies of the sovereign platforms studied in Chapters 2 and 3. They are promises to use future revenues to repay immediate loans.

What price will investors pay for a sovereign debt? At issuance, investors will consider two distinct reasons that the government-at-maturity might repay them. First, the government may prefer to repay the debt, all things considered. Second, the original promise of repayment may remain legally in force and constrain the government's actions.

Whether the original promise of repayment remains in force depends on the number and diversity of veto players who must approve its revision. Royal debts, for example, can be revised at will by the monarch. Holders of such debts should thus expect only a Machiavellian repayment – one hinging on their influence at court and their ability to make trouble should they not be repaid.

Even if the original terms of a debt remain legally binding, however, the government-at-maturity may not be significantly constrained. Some debts confer senior claims on ample revenue streams; these leave the government no discretion. Other debts confer junior or underfunded claims; these leave the government substantial discretion over whether and how to repay them.

Debt seniority and funding jointly determine creditors’ attitudes toward “constitutional commitment.” While holders of senior and well-funded debt crave better commitment, holders of junior or underfunded debt can only be hurt by increasing the number of veto players in the legislative process. Thus, the idea – widespread since North and Weingast (1989) – that improving constitutional commitment can only improve the credibility of debt repayment is mistaken.

I shall argue that England, in the first generation after the Revolution, issued many debt promises of high credibility but low face value. The high interest rates these early debts had to offer, and the discounts they suffered at sale, were not evidence that investors doubted the state would perform as promised. Rather, they were evidence of junior or poorly funded – and hence low-value – promises.

Those readers who find the argument sketched earlier straightforward may wish to skip to the next chapter. For those who seek a more careful exposition, this chapter provides a general model of the value of sovereign debts, shows that previous analyses have focused on special cases, and begins to discuss when and why English debt became more valuable.