1

International Studies Association Northeast Annual Convention

November 6, 2015

Panel: Topics in International Political Economy

“Civil Wars, Central Banks, and the Perception of Lenders”

Adam KnightDoctoral Student, Rutgers University

adam.knight87@gmail.com

Sovereign lending is a risky proposition. Any number of crises can lead a state to repudiate its debts. A loss in a civil war is an excellent example of such a crisis, as the state could no longer exist, the government could be overturn, or the state could lose some portion of territory. Any of these outcomes make a sullied reputation from default seem acceptable in comparison. In spite of the likelihood of repudiation, I show that lenders not only continue to lend to states in the midst of a civil war, but remain susceptible to states’ signals regarding their willingness to honor their debts during such conflicts. One such signal is the establishment and maintenance of a central bank. In spite of the bank’s reliance upon the state for its continued existence, its presence dramatically reduces borrowing costs for the state in the midst of a civil war. This result speaks not only to the power of signaling in sovereign lending, but also to the degree to which lenders can be manipulated by a skillful regime.

[Key Words: Civil War, Institutions, International Finance, Risk, Political Economy, Perceptions, Beliefs]

Draft for ISA NE: Please do not quote without permission

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Introduction1

Paul Poast’s article “Central Banks at War” ends with the conclusion that central banks

reduce sovereign borrowing costs during interstate wars.2 The implication here is that central

banks reduce borrowing costs under suboptimal conditions. However, the particular

circumstance of interstate war is one which allows the author to invest considerable weight into

the effect of central banks, as wars can bring to bear powerful incentives and even more

powerful disincentives.

Survival is the primary goal of the state, which undermines the ability of the state to

adequately guarantee adherence to the terms of its own promises to other states.3 Not

surprisingly, Stephen Krasner observes that defaults have not been uncommon historically,

arguing that the incentive to repudiate debt in times of crisis—be it a financial crisis or a war—

makes sovereign lending an especially risky proposition.4 Nevertheless, it would appear from

Poast’s analysis that lending costs are significantly reduced in suboptimal borrowing periods by

the presence of an institution that is ultimately at the mercy of the state.

As noteworthy as this conclusion is in the circumstance of interstate war, should a similar

relationship be found in civil wars the effect that Poast discovered may be even more powerful

than he supposed. Wars carry enormous monetary costs, but in spite of this state death has

become a rare occurrence.5 However, civil wars carry the possibility of loss of territory or even

the liquidation of the extant regime. Given the existential character of the costs of losing a civil

war, one would expect that central banks would not function as they do in interstate wars during

1 I would like to thank Paul Poast for his invaluable advice regarding this project.2 Poast, Paul, “Central Banks at War,” International Organization. Vol. 69, No. 1 (Dec. 2015), pp. 90-913 Mearsheimer, John, The Tragedy of Great Power Politics, W.W. Norton & Co., 2001, pp. 30-24 Krasner, Stephen, Sovereignty: Organized Hypocrisy, Princeton University Press, 1999, pp. 129-315 Christia, Fotini, Alliance Formation in Civil Wars, Cambridge University Press, 2012, p. 51; it should be noted, though, that it was more common before WWII than it has been since.

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civil wars. This expectation rests upon the idea that lenders believe that the borrower might lose,

though.

If a lender believes that the borrower will dispatch its adversaries, then said borrower has

little to fear from lending to a borrower during a civil war. However, should that borrower be

viewed as vulnerable by lenders, its borrowing costs would be substantially higher than

otherwise. One expects, then, that sovereign borrowing costs depend on how confident lenders

are that the borrower will win the war, given the enormous costs of losing a civil war. The

existence of a central bank under the control of the borrower can serve as an important signal

related to this.

What one is left believing depends upon one’s beliefs regarding how good lenders are at

weighing risks during civil wars. If one believes that lenders are able to accurately measure the

risks associated with existential crises, then it must be concluded that central banks are a useful

signal of a regime’s resiliency. If one does not, then it must be concluded that central banks are a

useful tool to overstate the borrower’s stability in the face of adverse conditions.

Central Banks

A central bank can be a powerful reputation-enhancing instrument. Poast reasons that this

is due to the fact that central banks eliminate a credibility problem on the part of the borrower

and a pair of problems on the part of lenders. The problem on the part of the borrower consists of

the incentive the sovereign has to not repay its lenders, particularly given the lack of an

“authoritative entity that can force the sovereign to honor its debt obligations.”6 The first of the

lenders’ problems consists of the fact that one of the few recourses lenders have to deal with this

problem—withholding loans—is detrimental to the lenders themselves, as the greater the risk

6 Poast, “Central Banks,” p. 67

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associated with sovereign debt as an asset, the greater the promised return.7 The second problem

is that of collective action—if states are determined to collectively withhold loans to a state, the

return on sovereign debt will increase significantly, powerfully incentivizing defection. This

incentive makes punishing states for default particularly difficult.8

Central banks solve both of these problems by becoming the only direct purchaser of

sovereign debt. This dramatically increases the cost of default (assuming the continued existence

of the bank),9 which in turn eases the concern of lenders concerned about a return on their

investment, as the state with the bank is now properly incentivized to repay. Furthermore, the

collective action problem is circumvented as the bank is the only lender dealing directly with the

sovereign. The end result of this is a sovereign who enjoys consistently lower borrowing costs

because of the self-imposed limitations of having a central bank, but what about when the

suboptimal borrowing conditions include an existential threat to the state itself? The literature

suggests that lenders may not be as perceptive as is optimal regarding this risk.

Tomz and Reputation

Sovereign lending is a risky proposition. Any number of crises can lead a state to

repudiate its debts. This makes information especially important for lenders, as one must be able

to accurately judge not only the likelihood of crisis, but also the likelihood that the borrower will

be able to weather such a crisis without repudiating its debt. This is easier said than done; Gregor

MacGregor was able to raise hundreds of thousands of pounds selling the debt of the fictitious

country of Poyais in 1922 and 1923.10 It was not until news of a disastrous expedition to the

7 Ibid. pp. 67-698 This does not mean that there are no enforceable consequences for default. Alexander Gumbel and Oren Sussman discuss potential domestic sources of enforcement in “Sovereign Debts without Default Penalties,” The Review of Economic Studies, Vol. 76, No. 4 (Oct. 2009), pp. 1297-13209 Poast, “Central Banks,” pp. 69-7310 Tomz, Michael, Reputation and International Cooperation: Sovereign Debt Across Three Countries, Princeton University Press, 2007, pp. 50-54

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supposed state reached European investors that Poyaisian debt was treated substantially

differently than the debt of South American states that actually existed.

Michael Tomz argues that this case illustrates the importance of reputation in sovereign

lending. Absent information to the contrary, lenders treat new borrowers with a healthy measure

of skepticism.11 As the Poyaisian case demonstrates, this may be wise. Lenders have difficulty

distinguishing between new borrowers, though. As time passes and lenders gather points of

information (and loan repayments), they have an easier time differentiating between safe and

risky investments, but there are shortcuts one can take to a good (or repaired) reputation as a

borrower.

The relative weight of a sovereign’s actions are dependent upon the general financial

climate in which those actions take place.12 For instance, if a sovereign adheres to its debt

obligations when lenders expect otherwise, the sovereign’s reputation dramatically appreciates.

Argentina’s reputational improvement during the 1930’s is particularly noteworthy. British

lenders reacted with surprised gratitude at their repayments, dramatically reducing the country’s

borrowing costs. This case is noteworthy not merely for this appreciation, though. Argentina had

defaulted on loans several times before, but this seemed to be of little concern.

The case of Argentina highlights one important limit of reputation as an enforcement

mechanism—the limited cost of default.13 Tomz argues that creditors do not leverage military

might to enforce loan obligations or effectively apply trade sanctions against debtors in arrears.

Even collective retaliation appears to be of little consequence. The primary “cost” of default, it

seems, is an inability to secure additional loans. Although a sovereign suffers higher costs

associated with borrowing, this is temporary—as long as the state settles its outstanding defaults

11 Ibid. pp. 49-6912 Ibid. pp. 102-11213 Ibid. pp. 63-65 88, 152-153 194-195, 218-219

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and makes scheduled repayments, the cost of borrowing drops consistently from year to year

until approaching the pre-default cost.14

The appreciation in value of Argentinian debt becomes justifiable when one bears in

mind one important fact—predicting default can be difficult, even in the modern context.15 A

lender who relies entirely upon economic factors to set the risk premium on borrowing is left

with an incomplete depiction of potential borrowers. Lenders must also try to gauge how willing

a sovereign is to act in accordance with its debt obligations, as enforcement mechanisms cannot

force delinquent borrowers to do so.16

Douglass North and Barry Weingast argue that the reputation effects associated with

default are insufficient to guarantee the honoring of sovereign debts,17 yet according to Tomz,

this is primary means of enforcement and information gathering with regards to these debts.

North and Weingast note the importance of institutions in supplementing reputation as an

enforcement mechanism, but given the shrinking shadow of the future of a regime locked in

existential combat and the likelihood that should the regime fall its debts shall be repudiated,18

this hardly seems sufficient. Given the travails of international finance—and indeed,

international cooperation in general—this can hardly come as a surprise. Although no longer

absolute, the doctrine of sovereign immunity dramatically limits the degree to which a sovereign

can be held to her word.19 14 This conclusion is not unique. Another example of such a depiction of default recovery can be found in Cole, Harold L., James Dow, and William B. English, “Default, Settlement, and Signaling: Lending Resumption in a Reputational Model of Sovereign Debt,” International Economic Review, Vol. 36, No. 2 (May, 1995), pp. 365-38515 Panizza, Ugo, Federico Sturzenegger, and Jeromin Zettlemeyer, “The Economics and Law of Sovereign Debt and Default,” Journal of Economic Literature, Vol. 47, No. 3 (Sep., 2009), pp. 667-671; The authors note that in spite of the established correlations between pre-default behavior and defaults themselves, it is difficult to establish a causal relationship thereby.16 Tomz, Reputation, pp. 14-1617 North, Douglass C, and Barry R. Weingast, “Constitutions and Commitment: The Evolution of Institutional Governing Public Choice in Seventeenth-Century England,” The Journal of Economic History, Vol. 49, No. 4 (Dec., 1989), pp. 805-80818 Tomz, Reputation, p. 22; post-revolutionary Russia serves as a good example of this sort of outcome.19 Panizza, et al., “Economics and Law,” pp. 653-655

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To make matters worse for lenders, the independence of central banks is neither constant

nor consistent. Several countries have placed substantial limits upon their central banks.20 Even

the vaunted German Bundesbank is not entirely isolated from political whims—it is required to

adopt policies which assist in the functioning of the policies of the current German government,

so long as those policies are not necessarily unsound from a monetary standpoint. Given the

weakness of the enforcement mechanisms, one would expect them to fail should they be

subjected to the considerable stress of a civil war.

A civil war fought over control of the state itself pits a state’s loan obligations against its

will to survive. Given the salience of the latter, one would expect not only that default would

follow, but that lenders would expect as much. Lenders should therefore demand enormous

interest on loans given under these circumstances or should simply refuse to lend. Granted, not

all civil wars are fought over the control of the state as a whole; some are merely secessionist

conflicts. While a control of a portion of a state’s territory is a less powerful motivator than the

state’s very existence, it is nonetheless enormously powerful; Krista Wiegand argues that

territorial disputes are more than sufficient to manifest repeatedly as a casus belli.21 And yet,

lenders continue to lend during such crises. Given this behavior and the insufficiency of

institutional and reputational enforcement mechanisms, one should expect that curious episodes

of lending should be common during civil wars.

The American Civil War

One such episode can be found in the performance of Confederate cotton bonds during

the American Civil War. The sale of these bonds was absolutely critical to the capital-starved

20 Eijffinger, Sylvester C. W., and Jakob De Haan, “The Political Economy of Central-Bank Independence,” Special Papers in International Economics, Vol. 19, (May, 1996), pp. 22-2821 Wiegand, Krista E., Enduring Territorial Disputes: Strategies of Bargaining, Coercive Diplomacy, & Settlement, University of Georgia Press, 2011, pp. 1-17

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Confederacy—the would-be country had precious few avenues for generating any kind of

financial asset.22 In spite of this, the bonds held their value remarkably well over the course of

the war, in spite of the conflict’s trajectory. The cotton bonds’ performance is doubly surprising

due to the conditionality of the bonds themselves—the cotton promised to purchasers would only

be supplied upon the establishment of peace with the Union.23 Although one might assume that

losing a war over a would-be state’s existence would jeopardize the value of outstanding debt

obligations, this clause erases all doubt.

The price of the bonds was reactive to war news, to be sure.24 Union victories at

Gettysburg and Vicksburg permanently damaged the bonds’ value. However, news of Union

advances turned back and the presidential campaign of George McLellan—who advocated suing

for peace with the Confederacy—led to the recovery of most of the bonds’ value. Curiously,

though, it was not until the fall of Charleston that their value began to collapse. Even after this

point—when the now victory-dependent loans ought to have been treated as worthless pieces of

paper—they were still being traded, albeit at profound discounts.

This story serves two purposes. First, it demonstrates that international lenders are

capable of underestimating the dangers of lending during a civil war, even when one is

ostensibly aware of the potential consequences. Second, it demonstrates that this effect remains

even as the war goes badly for the side to which the lenders in question have lent. One may

suppose that given the fact that British trade in cotton bonds did not cease until the Confederacy

had been dissolved, then one might expect that lenders in general may be susceptible to

underestimating the dangers associated with lending during a civil war.

22 Lester, Richard I., Confederate Finance and Purchasing in Great Britain, Virginia University Press, 1971, pp. 4-1023 Brown Jr., William O., and Richard C.K. Burdekin, “Turning Points in the U.S. Civil War: A British Perspective,” The Journal of Economic History, Vol. 60, No. 1 (March 2000), pp. 216-21824 Ibid. pp. 218-225

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Hypothesis

Central banks, in spite of their institutionally guaranteed limitations, are powerful signals

to lenders. Lenders should be susceptible to such signals, as they rely so heavily upon reputation

in determining the market value of a particular country’s sovereign debt. Furthermore, as the

American Civil War demonstrates, lenders are capable of underestimating the risks associated

with lending during a civil war for a state’s existence (in the case of the Confederacy). Therefore

I am proposing the following hypothesis.

Hypothesis 1: Central banks reduce borrowing costs during civil war.

Civil wars represent a more stringent test of the effect of central banks than interstate

wars, as the state is in more danger in the former than the latter. State death is a rare occurrence,

all things considered, however, the liquidation of a civil war belligerent is far more common.25

These dangers make two adverse outcomes (for lenders) more likely. The first is the repudiation

of debts by conquering rebels. The second is a default in the face of the state’s shrinking shadow

of the future, an effect brought on by the increasing possibility of the first outcome. These

concerns ought to override the effect of a central bank, especially given its subordinate position

with regards to the sovereign. However, given their reliance upon reputation and the apparent

utility of central banks in bolstering a sovereign’s reputation, I propose that they will continue to

function under conditions of civil war.

Design

In order to test this hypothesis, I have extended Poast’s analysis of central banks during

interstate wars, altering his models to examine the interaction between the existence of a central

bank and a civil war on borrowing costs. Poast incorporated an impressive nine separate

analyses, each of which are replicated herein. The tests themselves are: a vanilla ordinary least

25 Christia, Alliance Formation, p. 51

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squares (OLS) (model 1); OLS with a lagged dependent variable (LDV), fourth-degree time

polynomial, and both fixed and random effects (models 2 and 3, respectively); feasible

generalized least squares (FGLS) with an LDV, first-order auto-regressive (AR(1)) correction,

and both fixed and random effects (models 4 and 5 respectively); Fixed effects vector

decomposition (FEVD) with an LDV, both without and with AD(1) correction (models 6 and 7);

a model with an LDV, AR(1) correction, Driscoll-Kraay standard errors, both without and with

fixed effects (models 8 and 9, respectively).

The vanilla OLS is present primarily as a benchmark, as I am more interested in the

results from the other models. Other OLS models include a lagged dependent variable, an

appropriate wrinkle given that the data is arranged as panel data, or time series cross-sectional

(TSCS) data. The inclusion of FEVD models and models with Driscoll-Kraay standard errors are

particularly useful due to potential issues with relying on fixed effects when analyzing panel

data, namely the issues of slowly changing variables and cross-sectional correlations.26 This is

especially important given the problems with using an alternative thereto.

I conducted a Hausman test to determine the appropriateness of fixed or random effects

in this analysis’s models. The results suggest problems with the models assuming random

effects, as the results of the test were profoundly statistically significant (with a chi-square

statistic of 40.43, and a p-value of < .001). Given the apparently systematic differences between

the fixed and random effects models, I will favor the results of the fixed effects models. In spite

of this, I still include the random effects models, although I will discount their impact in my

discussion of the results.

The data used to represent borrowing costs consists of the London sovereign debt market

from 1816 to 1914, once again mirroring Poast’s model. Beginning the dataset earlier or ending

26 Poast, “Central Banks,” pp. 81-83

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it later would each produce problems. First, the end of the Napoleonic wars marked a sea change

in international finance marked by two major shifts. The first is a dramatic rise in the number of

countries who bore substantial international debts.27 On a related note, the second is an expansion

in the tools available to advanced countries to avoid default.28 The problem with extending the

dataset beyond 1914 is that after the First World War, the application of central banks changed.29

During the time period of the analysis, central banks were used primarily as a means to finance

war. Afterward, their use shifted to controlling inflation.

The data used to depict the existence of a central bank comes from Poast’s purpose-built

dataset of central bank creation, existence, and dissolution, itself a product of multiple sources.30

The specific figure of note in the following multivariate analyses shall be whether or not the

existence of a central bank interacting with the question of whether a civil war is happening

relates to the borrowing cost figure negatively. The data used for the civil war figure comes from

the Correlates of War (COW) project from the corresponding time period.

Controls

One would suppose that lenders are sensitive to a wide range of conditions as it pertains

to the interest they demand from a loan. As such, several of the controls from Poast’s original

model shall be included in the models to ensure that this multitude of reasons that bond yields

may rise or fall do not interfere with ascertaining the real relationship between bond yields

during civil wars and central bank operation.

There are several different reasons to control for the existence of representative

institutions. First, representative institutions tend to correlate with more transparent governments 27 Reinhart, Carmen M., and Kenneth S. Rogoff, This Time It’s Different: Eight Centuries of Financial Folly, Princeton University Press, 2009, p. 7028 Qian, Rong, Carmen M. Reinhart, and Kenneth S. Rogoff, “On Graduation From Default, Inflation, and Banking Crises: Elusive or Illusion,” NBER Macroeconomics Annual, Vol. 25, No. 1 (2010), p. 629 Poast, “Central Banks,” p. 6530 Ibid. pp. 76-77

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which,31 given the importance of information to the development of reputation, is reason enough

to control for their existence. The fact that there may be correlations between democracy and the

degree of governmental control of monetary policy only reiterates the importance of this

control.32 This control consists of the Polity IV “executive constraints” measure.

Controls for several economic factors will also be included in the model. Total

population, urbanization rate, iron and steel production and the growth therein are all indicators

of ways in which borrowers may marshal resources to repay their debts. All can be used as

indicators of the size of the economy involved, and iron and steel can be an indicator of both

economic growth and the ability to go conduct a war. Moreover, population and urbanization in

particular have been identified by Mark Dincecco as indicators of a country’s tax base, a

necessary revenue source in states’ efforts to repay loans.33 I use COW figures for these controls.

On a related note, given the impact of economic openness on performance, a control for

membership in a trade agreement is included, incorporating Robert Pahre’s measure of the

phenomenon.34

Kenneth Scheve and David Stasavage introduced an important wrinkle to sovereign

lending scholarship. They argue that a sovereign may forgo borrowing funds from abroad by

increasing the highest tax rate on inherited wealth.35 The purpose of this maneuver is to fund a

state’s mobilization to war, one of the primary purposes of central banks during the time period

examined. Thus, increasing taxes on inherited wealth may serve as a substitute for a central bank.

31 Hollyer, James R., B. Peter Rosendorff and James Raymond Vreeland, “Democracy and Transparency,” The Journal of Politics, Vol. 73, No. 4 (October 2011), pp. 1191-120532 Cohen, Benjamin J., International Political Economy: an Intellectual History, Princeton University Press, 2008, pp. 156-15733 Dincecco, Mark, “Political Regimes and sovereign credit risk in Europe, 1750-1913,” European Review of Economic Hostory, Vol. 13, No. 1 (Apr. 2009), pp. 45-4634 Pahre, Robert, Politics and Trade Cooperation in the Nineteenth Century: The “Agreeable Customs” of 1815-1914, Cambridge University Press, 2008, pp. 157-17635 Scheve, Kenneth, and David Stavasage, “Democracy, War, and Wealth: Lessons from Two Centuries of Inheritance Taxation,” American Political Science Review, Vol. 106 No. 1 (Feb. 2012), pp. 81-102

13

As such, Scheve and Stasavage’s measure of the highest inherited wealth tax rate is included as a

control.

It should be apparent that internal crises would be a logical control for this analysis, as

their occurrence has coincided with spikes in sovereign borrowing costs.36 Interestingly, there

have been several studies which attempt to establish a link between political instability to the

degree to which central banks maintain their independence.37 Sylvester Eijffinger and Jakob de

Haan conclude that the nature of this relationship is uncertain, but the potential for crises to

interfere with the examined relationship is sufficient to justify the control. The data for this

variable come from the COW dataset.

There exists ample literature discussing the effect of the gold standard. For example,

Britain’s decision to abandon the policy during the Napoleonic wars caused some measure of

economic hardship (in the form of inflation).38 This makes controlling for the policy an easy

decision. It was also an easy decision to control for previous default, as Tomz notes the

substantial reputational cost of doing so.39 For this control, I use the measure for the gold

standard developed by Christopher Meissner.40

Finally, it stands to reason that war would be included in the battery of controls, as one of

the contingent parts of Poast’s analysis is that war makes borrowing more costly under normal

circumstances.41 The more interesting decision is that of including colonial war among them as

well. It is easy to see how one might view colonial conflicts as not conceptually dissimilar to

civil wars, however the literature on the subject suggests that this is not the case. Colonial wars

36 Tomz, Reputation, p. 5637 Eijffinger and De Haan, “Central-Bank Independence,” pp. 44-4638 Bordo, Michael D., and Eugene N. White, “A Tale of Two Currencies: British and French Finance During the Napoleonic Wars,” The Journal of Economic History, Vol. 51 No. 2 (June, 1991) pp. 303-305 39 Tomz. Reputation, p. 88 40 Meissner, Christopher M., “A New World Order: Explaining the international Diffusion of the Gold Standard, 1870-1913, Journal of International Economics, Vol. 66, No. 3 (July, 2005), pp. 385-40641 Poast, “Central Banks,” pp. 63-65

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are described as “extrasystemic,” neither interstate nor intrastate.42 This is an important

distinction as the salience of territory does not seem to extend to colonial holdings (or, at the

very least, it seems that it is treated as not quite as salient.43 Nonetheless, it still represents a

potential loss and instability in general, making the decision to control for it a natural one. The

figures for these variables come from the COW dataset.

Results

Table 1EstimationU.S.E.Time Dynamics

(1) OLSNoneNone

(2) OLSFixed

LDV & Year Polynomial

(3) OLSRandom

LDV & Year Polynomial

(4) FGLSFixed

LDV & AR(1)

(5) FGLSRandomLDV & AR(1)

Central Banks

-0.18***(0.03)

0.02(0.03)

0.01(0.02)

0.01(0.04)

-0.02(0.02)

Civil War -0.18***(0.05)

-0.00(0.03)

-0.01(0.03)

-0.04(0.03)

-0.03(0.03)

CB * CW 0.04(0.09)

-0.11**(0.05)

-0.11**(0.04)

-0.09*(0.05)

-0.11**(0.05)

ControlsRep. Inst. 0.07**

(0.03)0.02

(0.03)0.02

(0.02)0.08*(0.04)

0.02(0.03)

Top Tax Rate

-0.03***(0.01)

0.00(0.01)

-0.00(0.00)

-0.01(0.01)

-0.01(0.00)

Trade Agreement

0.19***(0.04)

0.00(0.03)

-0.02(0.02)

-0.01(0.04)

0.02(0.03)

Iron and Steel pc

-0.25(0.39)

-0.06(0.28)

-0.20(0.19)

-0.03(0.43)

-0.16(0.29)

Total Population

0.00**(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

Iron and Steel Growth

-0.33(1.94)

-0.73(0.93)

-0.99(0.93)

-0.72(0.79)

-0.68(0.78)

Urbanization Rate

0.03(0.02)

0.02(0.02)

-0.01(0.01)

0.04(0.03)

0.00(0.01)

42 Sambanis, Nicholas, “What is Civil War? Conceptual and Empirical Complexities of an Operational Definition,” The Journal of Conflict Resolution, Vol. 48, No. 6, (Dec., 2004) pp. 825-82643 Wiegand, Krista E., Enduring Territorial Disputes: Strategies of Bargaining, Coercive Diplomacy, & Settlement, University of Georgia Press, 2011, pp. 1-9 183-184

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Internal Pol. Crisis

-0.010.05

-0.02(0.02)

-0.02(0.02)

-0.03(0.02)

-0.02(0.02)

Gold Standard

0.18***(0.04)

0.02(0.02)

0.03(0.02)

0.02(0.03)

0.04(0.03)

Default 0.20***(0.10)

0.00(0.05)

0.02(0.05)

0.00(0.04)

0.01(0.04)

Interstate War

0.06(0.05)

-0.02(0.03)

-0.03(0.03)

0.00(0.03)

-0.00(0.03)

Colonial War

0.04(0.04)

0.02(0.02)

0.03(0.02)

0.02(0.03)

0.02(0.02)

Spread at t-1 0.81***(0.01)

0.81***(0.01)

0.65***(0.02)

0.69***(0.02)

Constant 0.80***(0.07)

4241.07***(711.49)

-55.26(39.83)

0.39***(0.05)

0.25***(0.06)

Observations 1449 1449 1449 1426 1449* p < 0.1, ** p < 0.05, *** p < 0.01

Table 2EstimationU.S.E.Time Dynamics

(6) Vector Dec.FixedLDV

(7) Vector Dec.Fixed

LDV & AR(1)

(8) Drisc./Kr.None

LDV & AR(1)

(9) Drisc./Kr.Fixed

LDV & AR(1)Central Banks -0.01

(0.02)-0.06(0.05)

0.00(0.02)

0.03(0.04)

Civil War -0.02(0.03)

-0.05(0.03)

-0.02(0.02)

-0.02(0.02)

CB * CW -0.11**(0.05)

-0.08(0.05)

-0.11**(0.05)

-0.11**(0.05)

ControlsRep. Inst. 0.03

(0.03)0.07

(0.05)0.02

(0.01)0.03

(0.03)Top Tax Rate -0.01

(0.01)-0.01(0.01)

-0.00(0.00)

-0.01(0.01)

Trade Agreement

-0.03(0.03)

-0.01(0.04)

-0.01(0.03)

-0.03(0.03)

Iron and Steel pc

-0.12(0.31)

0.01(0.65)

-0.16(0.16)

-0.12(0.21)

Total Population

-0.00(0.00)

0.00(0.00)

0.00(0.00)

-0.00(0.00)

Iron and Steel Growth

-1.07(0.94)

-0.77(0.84)

-1.06(0.87)

-1.07(0.86)

Urbanization Rate

0.02(0.02)

0.04(0.03)

-0.00(0.01)

0.02(0.03)

Internal Pol. Crisis

-0.02(0.02)

-0.03(0.02)

-0.02(0.04)

-0.02(0.05)

Gold Standard 0.01 0.02 0.02 0.01

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(0.02) (0.04) (0.03) (0.04)Default 0.02

(0.05)0.01

(0.04)0.03

(0.04)0.02

(0.03)Interstate War -0.03

(0.03)-0.00(0.03)

-0.03(0.04)

-0.03(0.04)

Colonial War 0.02(0.02)

0.02(0.03)

0.03(0.02)

0.02(0.02)

Spread at t-1 0.81***(0.01)

0.68***(0.02)

0.82***(0.04)

0.81***(0.04)

Constant 0.25***(0.07)

0.40***(0.07)

0.15***(0.05)

0.23***(0.08)

Observations 1449 1401 1449 1449

* p < 0.1, ** p < 0.05, *** p < 0.01 Poast’s collection of models was singularly helpful for his purposes, and repurposing

them here yielded a similar outcome. While one can quibble with the utility of particular models

as compared with others, using nine models can mitigate this sort of criticism, assuming most of

the models predict a relationship that is statistically significant and oriented in the direction

predicted by the hypotheses. Seven of the total nine models conform to the hypothesis stated

herein, with only the baseline OLS and vector decomposition with both LDV and AR(1) not

predicting a relationship with statistical significance.

However, in spite of most of the models confirming the relationship as enumerated in the

hypothesis, only four of the six models that use fixed effects confirm that this relationship is

statistically significant at p < .05. Given the issues with random effects as identified by the

Hausman test, these results ought to weigh more heavily than the others. Although these results

are still promising, it may be reason enough to give a skeptic pause.

Discussion and What Comes Next

The results from this analysis are noteworthy but generate frustratingly contingent

conclusions. At the very least, these results demonstrate the considerable power of central banks

to reduce borrowing costs under adverse conditions. As is suggested by the literature and

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historical precedent, this is likely due to the degree to which the sovereign lending market is

dictated by reputation. The question of whether this is productive behavior or not is left

unsettled, though.

On one hand, it may well be that the performance of central banks during civil wars

demonstrates the irrational confidence lenders have in their own ability to judge risks by way of

examining the reputation of a sovereign. After all, the cost of a borrower losing a civil war may

be catastrophic to the lender. However, it may also simply be a reflection of lenders’ savvy. They

may be setting the price of borrowed capital to sovereigns with central banks during civil wars

based on the fact that a sovereign can use that cheaper capital to better fight its internal conflict.

By the very fact that other lenders are attracted to borrowers with central banks, lenders can

justifiably offer capital at lower borrowing costs to those borrowers.

The best way to determine which possibility best reflects reality is to extend Poast’s

analysis further. The risks associated with wartime lending (especially during civil wars) are

inextricably tied to the possibility that the sovereign may well lose. As such, incorporating the

outcomes of civil wars is a logical next step. This is easier said than done, though. Only certain

outcomes are of interest—specifically the liquidation of the state by way of revolution or the loss

of territory by way of secession. Incumbent victories or more limited manifestations of defeat are

not theoretically pertinent.

Even considering this innovation, outcome data would not entirely capture the

phenomenon. The primary threat of a revolution—as far as the lender is concerned—is tied to the

likelihood that the new regime will simply repudiate the loans of the previous one, but this is not

the only such threat. The primary threat of secession is that the sovereign will value the loss of

territory associated with secession and default on its loan commitments rather than lose a civil

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war, not necessarily because it loses a war. Similarly, a sovereign facing a revolution may

default in order to secure the short-term gains necessary to combat the revolution. As such, civil

wars themselves must be differentiated based upon what is at stake, not just by what happens at

the end.

Worse, there are some substantial issues with the COW dataset, posing potential

problems for both this analysis and the proposed extension. Dan Reiter, Allan Stam, and Michael

Horowitz find that the dataset’s interstate wars are incorrectly coded in one way or another at a

remarkable rate—especially given the degree to which scholars rely upon it.44 Without a feasible

alternative, however, one can only hope that the issues with the dataset do not lead to

problematic results.

Some other logical extensions of this analysis can be more easily accomplished. First,

although there would be some issues involved with extending the list of cases, it would be useful

to incorporate data from more contemporary time periods. Civil wars have become more

prevalent over the course of the last 60 years, several of which have demonstrated novel

behaviors which have substantially changed scholarly opinions on the matter. For instance, in the

post-Cold War context, civil wars—which had previously been settled primarily by way of

decisive military victory—are being settled by way of negotiation.45 This is an important

development theoretically to be sure—after all, it is unclear from this piece alone how lenders

would treat this outcome. More to the point, though, it is important from a policy standpoint that

lender behavior during civil wars be analyzed in a context where this outcome is a seriously

considered possibility.

44 Reiter, Dan, Allan C. Stam, and Michael C. Horowitz, “A Revised Look at Interstate Wars, 1816-2007,” Journal of Conflict Resolution (forthcoming), published online October 16, 201445 Toft, Monica, Securing the Peace: The Durable Settlement of Civil Wars, Princeton University Press, 2010, p. 7

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