Okay, maybe investing the whole country’s assets into Dogecoin wasn’t the best move. No need to
point fingers here - but the treasury is empty. The whole country is broke,
the people are demanding supplies, and the creditors are at the door.
There’s only one thing left to do - declare bankruptcy!
But what happens when a country declares bankruptcy exactly?
Most people have probably only heard of bankruptcy in terms of businesses and
individuals - such as when a beloved local food chain closed up shop. Rest in peace, Steak & Ale,
your lunch specials won’t be forgotten. Or when Uncle Billy’s gambling debts got a little
too high and his whole family had to throw in the towel on their payments. But those people
rarely have too much power to determine the terms of their bankruptcy, and the
banks usually make sure they get as much as they can out of them before the debt is wiped clean.
National bankruptcy is a very different matter - because who
has more power than an actual head of state?
A country’s bankruptcy is actually called sovereign default - and it basically boils
down to the country no longer saying “I’m good for it, the check’s in the mail” and switching to
“Actually, I’m not good for it and you can’t make me pay”. The government usually owes a lot of
money to both domestic and foreign debtors, and they simply announce that they’re defaulting on
the debt and no more payments will be coming. They can publicly repudiate their debts,
or just stop paying and let everyone figure it out as the cash stops coming.
But what could bring a country to these dire straits?
Many countries run a national debt, but most are at least able to make consistent payments - even
if in some countries, the debt only seems to go up. But if you’re paying the older creditors
first and making payments in a timely fashion, that’s just the cost of doing business. Even so,
multiple things can cause a debt to spiral out of control, and once a country’s gross national
product goes down enough, the interest on the debt becomes incredibly daunting and the country
enters terminal debt - when the payments don’t equal the interest and the debt keeps going up
even without borrowing something new. Then the only way out is to simply flush the debt.
But circumstances can sometimes make things much worse.
Many of the countries that default on their debts are the architects of their own misery. They made
poor investments, didn’t take enough care of their own financial sector, and lent money to
the wrong people. A history of this behavior can lead to a poor credit history, which makes it
harder to get future loans. But outside factors can also cause debt to spiral out of control,
such as when a major part of the market the country relies on is disrupted. If your country
has one major export, a bad season for crops or a disaster in the shipping sector can throw
a whole year’s profits out the window. And then there’s the danger of inflation, which can devalue
a nation’s currency and mean that one dollar pays off a much smaller portion of the debt than usual.
And that was never more clear than in 2020.
When the entire world shut down due to Covid-19, whole countries saw their economies grind to a
halt. Millions of people were out of work, and many countries saw no other
way to keep public order than to print an enormous amount of money for relief efforts.
This caused heavy inflation in multiple countries that the world is still dealing with,
and even today we see major shipping delays due to cities suddenly locking down and halting commerce
in its tracks. The US hasn’t had to default on any of its debts due to the pandemic - its coffers are
way too deep for that - but it hasn’t stopped economists from looking nervously at the charts.
But there’s another reason nations might default on their debts.
It’s good old politics. Many countries racked up extensive amounts of debt when they were under
colonial rule, or had more powerful nations set the terms of trade. The national debt is
a source of resentment for the people, and when a new populist government takes charge - be it
through an election or a revolution - one of the first things they do is declare a new constitution
complete with the power to discharge the national debt. There’s a lot of celebrating in the streets,
followed by a lot of hard questions about exactly what that means for future trade deals.
In this case there are two primary kinds of state bankruptcy.
The first, insolvency, is the more common of the two. It’s usually a situation where
the state has hit rock bottom and would be devastated by trying to pay off its entire debt.
This is usually a combination of heavy public debt, lower tax revenue due to high unemployment,
a declining stock market, and a public that would revolt if harsh austerity
measures were instituted. So the government basically announces that they won’t be able
to pay off their full debt, and try to negotiate a settlement that will either
forgive some of their debts or allow them to pay them off at a slower rate.
But some states are in an even worse fix.
Illiquidity is when the state is in a more serious immediate financial crisis,
and can’t liquidate assets fast enough to even meet its interest or principle payments in the
next cycle. This is an imminent default, and usually requires a full halt of payments until
enough assets are freed up. While this might seem more serious, it’s also often much more temporary,
and states often try to negotiate a temporary halt without asking for their full debt to be
discharged. The tricky part is that it’s not easy to prove whether or not this is genuine.
But in thorny political climates, another x-factor emerges.
Post-revolution, or an election that might as well be a revolution, some states not
only stop paying their debts - they might take the property of the people they owe money to.
This is a concept called odious debt, which states that debts incurred by a despotic regime
are the responsibility of the regime rather than the country. While this is intended to
relieve a people free of a dangerous government of its obligations, it can be used in other,
less conspicuous ways- such as when the Confederate States not only disavowed their
debts to the union, but seized a military fort belonging to the federal government.
But there’s no such thing as a free lunch. So what
actually happens when a country calls it quits on its debts?
For civilians in the United States, there is usually a structured process to clear
the debts and get back into good standing. For individuals and businesses who have hit rock
bottom and need a fresh start, the most common type is Chapter 7, which is basic liquidation.
The debtor signs on the dotted line, their assets are seized by the authorities and liquidated,
and used to pay off as much of their debts as possible. It’s unlikely that any business that
declares this will still be around unless they’re purchased, and any individual who declares Chapter
7 will likely be forced to forfeit any significant assets including their house in many cases.
Of course, it's good to be a big gun in some situations.
Say you’re a powerful businessman or individual who made some…questionable investments. That darn
Dogecoin again, maybe. Your income stream has gone bust, you’re heavily in debt, but you know
it’s only a little while before you’re back on top. That’s when it’s time to declare Chapter 11,
aka the rich man’s bankruptcy. This is a rehabilitation or reorganization bankruptcy,
most commonly used by businesses. The company undergoes a significant financial reorganization
and may have to sell off some assets, but remains functional as it repays its debt.
Some of the biggest names in business have declared bankruptcy multiple times,
including a certain former President.
And for unusual cases, the government has a plan as well.
Chapter 9 is reserved for municipal bankruptcy, when a town or city goes bankrupt and needs to get
out from under state or federal debt. This usually involves a monitor retooling their finances,
but it’s rare for a municipality to simply go away. Chapter twelve is a special bankruptcy
dispensation for family farmers and fishermen that is likely to let them keep the assets
that allow them to make a living. And then there’s chapter 15, which handles
complex cases of international debt and allows cooperation with foreign bankruptcy courts.
But how do you enforce a bankruptcy ruling against a whole country?
The answer is in most cases…you don’t. National bankruptcies really aren’t
arranged bankruptcies but simple defaults on the debt. Anything that happens beyond that
is more a question of diplomacy, and what the country that’s defaulting can agree to based
on their assets and their national climate. And while it may feel like the right thing to do for
a country drowning in debt, the consequences of sovereign default can be nasty. Right away, they
start feeling the impact in more ways than one - and it can sometimes make a bad situation worse.
But the problems don’t stop there.
For one thing, the creditors are hit immediately - and this can create a cascading effect. If
a creditor has lent a significant amount of money to a country and it gets defaulted on,
it affects the creditor’s ability to lend out money to other clients. When it comes to
a national scale, this can mean many countries go without vital assets. This is why repaying
creditors in some form is usually the first step in attempting to resolve a sovereign default,
and brings a lot of people to the negotiating table. Creditors often accept a low-ball offer
from the defaulting country to get what they can, although sometimes they hold out for a
change in government to try to get a better deal - but that can come with major risk.
And it hits the state harder than anyone.
The state might dismiss its financial obligations when it defaults, and that frees up a lot of money
in the coffers. But the good times don’t last - if they ever start. Few things will hurt a
state’s reputation with its creditors more than a default, which might make it next to impossible to
get future loans. Not only that, but it can cause serious diplomatic consequences if the state owes
heavy debts to other countries. In the best of circumstances, it might make it harder to trade
with those countries in the future. In worse scenarios, the value of the state’s currency in
international affairs might go out the window and the leadership could find themselves ostracized.
And this can trickle down to the citizens - badly.
If the state defaults on its debt, the leadership might think this would resolve its financial
problems. The reality turns out to be anything but rosy. The state still has empty coffers and
limited assets, the people have needs, and the government might be toppled if they fall down
on their basic duties. This often leads to the government ordering the printing of more money,
which solves the immediate issue - but leads to heavy inflation and hurts the country even
more in international trade as their currency gets devalued. In moderate situations, this
makes the cost of imports much higher. In worse cases, like in Zimbabwe, it can result in bizarre
scenarios like people paying with wheelbarrows of near-worthless currency to buy food.
And this can create a cascading effect.
If the state defaults on all its debts, including domestic debts,
banks might have to write down massive debts and cause a banking crisis. This then spins out into
a larger economic crisis as people panic and withdraw their money from the banks. The stock
market tumbles, and panic leads to panic as the public’s fears make a bad situation worse.
As the currency decreases in value and the faith in the government does as well,
the country is more likely to suffer through heavy unemployment, austerity, and criminal activity.
But the consequences of a sovereign default depend heavily on the prestige of the country.
Phillip II of Spain was a powerful king in the 1500s, but financial skill wasn’t his
best asset. He wound up defaulting on debt four times between 1557 and 1596,
and each time the full hit wasn’t taken by the Spanish crown - but by the powerful
Fugger banking empire in Germany, which had heavy investments in the Spanish crown. With
no way to enforce a judgement against a powerful monarch with the western world’s mightiest armada,
the Fuggers took the loss and eventually folded, ending a financial empire
that spanned centuries leading to the banking world being thrown into chaos.
And in more modern times, it’s common for countries to get in over their heads.
The 1800s was a chaotic time, as many former colonies gained their
independence from world powers and had to sort out their economies for the first time.
That included several Latin American countries, who went to the London bond market to get loans.
They quickly found their debts spiraling as the interest racked up. But as the bondsmen mainly
wanted to get their money back, they were open to renegotiating the loans and setting
up long-term repayment plans - and both sides kept the opportunity for future deals wide open.
But a hundred years later, new problems would emerge.
In the 1920s, as a financial crisis hit the globe - most famously,
with the Great Depression in the United States - many countries started instituting
protectionist policies. Tariffs rose, international trade decreased, and that
unbalanced many countries’ economies. Those that relied heavily on exports to fill their coffers
found themselves struggling to pay off their debts. Most notably, Chile in 1932 hit terminal
debt when its scheduled repayments were higher on average than their entire exports. However,
the world would soon have much bigger concerns - World War II was coming.
But even in the modern-day, major nations can go bankrupt.
The entire world was rocked by a massive financial crisis again in 2007 and 2008 that left very
few countries unaffected. However, one country which suffered more than many others was Greece,
which suffered the longest recession of any advanced economy to date - and
it devastated just about every area of life. The government debt rose rapidly,
investors lost confidence in the Greek economy, and the government
had to raise taxes a whopping twelve times. No surprise, that led to significant social unrest
ranging from massive protests to violent riots. The government quickly tried to restore order by
getting bailout loans from multiple groups including the International Monetary Fund.
That should take care of things…right?
The government of Greece tried to negotiate its way out of debts,
getting private banks to agree to a 50% cut on the value of their debts. This was a debt relief
of a hundred billion Euros - and it didn’t do much good. The government was still massively in debt.
They proposed new austerity measures to repay their obligations, but the public rejected them
in referendums. The crisis dragged on and on to 2015, with Greece ultimately defaulting on its
International Monetary Fund loan - the first developed country to ever do so. This caused
stocks worldwide to tumble, people worried that Greece might pull out of the European market,
and options were limited for relieving the crisis. You can’t get blood from a stone, so Greece was
able to negotiate new terms for many of its debts. Their overall debt is still high, but by
2021 they were selling thirty-year bonds again for the first time since the financial crisis.
Of course, to resolve a debt crisis, you have to have a country wanting to pay.
Venezuela had been a thorn in the side of the United States and its allies
for well over a decade. First the fiery left-wing leader Hugo Chavez took control
and sought to create an anti-American bloc in South America. He was succeeded by his
protege Nicolas Maduro who became more authoritarian and increasingly isolated
Venezuela from the global economy, racking up the country’s debt. As its debts rose,
its economy crashed, and things only seemed to be getting worse. Sure enough, in 2017,
it defaulted on its debts and creditors around the world struggled to figure out their next move.
Is there any way to actually force a country to repay its debts?
Bond holders do have power in the global market, and if enough holders of a bond call in their
chips, it can create a cascading effect. But that’s not always possible - especially in a
country like Venezuela, where they likely do not have the money on hand to pay even a fraction of
their debts. As the grace period faded and the Maduro regime showed no intention of paying up,
the country was suffering far more than its debtors. It had struggled to provide
enough food or medicine for its citizens, resulting in massive lines for basic goods.
But Venezuela does have one asset that could help it dig itself out of this debt hole.
Under international law, creditors do have the ability to seek relief for their debt by
seizing the assets of the country that owes them money. This is only feasible if the country has
a significant amount of exports that can be taken from ships and ports, and Venezuela does have one
in particular - oil and lots of it. It’s their primary export, and one that maintains
its value and helps them forge diplomatic relations with other America-skeptic nations.
So why haven’t creditors called in their chips and held Venezuela accountable for its debt?
Because that could make a bad situation much worse - cutting off the country’s
primary income stream and making the country’s humanitarian crisis spiral out of control.
But what happens if things escalate?
Of course, foreign debtors have one more option for trying to recoup debt from a
country that is refusing or unable to pay it - declare war. This is usually a last resort for
creditors for a number of reasons. For one thing, a successful invasion is likely to devastate the
invaded country even further, making it harder to recoup the assets. And if the country doing
the invading puts the needed resources into it, it may cost a lot of money - potentially,
much more than the actual debt. Finally, this would worsen the relationship between the two
states and make negotiations harder - so the only way to force concessions out of the debtor
may be a costly, internationally condemned occupation or even a full annexation of the
country. All of these options might cause so much hardship in terms of money and lives lost
that the creditor nation might be more likely to just write off the debt.
But that’s not to say it hasn’t happened.
When the Confederate states seceded from the United States in 1861, the Union was split.
Some wanted to invade and take back the southern half of the United States,
while others thought the issues between the two regions were irreconcilable and a national
divorce might be the best approach to ending the conflict. That debate largely ended when
the South attempted to seize Fort Sumter and went on to be completely defeated and
reincorporated into the United States - although there was a silver lining. After the United States
ratified the 14th Amendment, they repudiated the debts held by the Confederate States.
But in most cases, the countries are motivated by a number of factors.
Why do companies repay their debts when they go bankrupt instead and just wipe the slate clean?
The first reason is usually fear. A country that defaulted on its debts will make a lot
of powerful enemies - and may want to avoid long-term consequences. Yes,
there’s the risk of military intervention, but the country could also find its assets seized
abroad by order of foreign courts, or find its currency blacklisted from international markets.
Either of these punitive economic measures could destroy their economy
and could cause more damage and have longer-lasting effects than even a war.
But sometimes, countries apply to the debtor’s better interests.
There are few things more valuable in international relations than your reputation,
and many creditors leverage that to get their money back. It’s the classic
puzzle of the carrot and the stick - if you threaten the debtor with harsh reprisals,
you might get the money back - or you might get nothing and burn your connections with
the country. That’s why many countries choose instead to work with the country
that went bankrupt - arranging a payment plan and even providing more immediate relief
to help the country get back on its feet. By eschewing retaliation of any kind, the creditors
invest in the country’s future and put themselves in prime position to benefit after the recovery.
It’d basically a national Chapter 11 - but what about the national equivalent of a Chapter 7?
When a company files Chapter 7, they usually cease to exist altogether. The company’s debts
are discharged, and their assets are liquidated to pay off their debts. But you can’t simply
abolish a country - or can you? It’s pretty rare for a country to be abolished in the modern day,
although there was one example that made news around the world - the Soviet Union.
The massive empire collapsed in the early 1990s, and had a massive debt when it did. Russia endured
but much of the empire split into new countries that had to start from scratch without a powerful
nation pulling their strings. And in the immediate aftermath, creditors around the world had to
scramble to figure out - who owes them what? While some tried to get payment from the newly
democratic state of Russia, their finances were not in the best of shape. New nations
like Ukraine, Estonia, Georgia, and Kazakhstan inherited some of the debt, but the chaos of
trying to figure out the economics complicated any attempt to recoup most of the debt.
So no one is going to put a for-sale sign on the
United States any time soon - but is the country in danger of a default?
Surprisingly, it’s come rather close in recent years. But the culprit wasn’t a war,
or a recession, or a change in government. It was one of the oldest plagues of the US
government - politics. The United States has a debt limit, capping the amount of
money the government can borrow. The US frequently borrows money to pay money,
so every few years they vote to raise the debt limit and move ahead with business as usual.
Sounds like a healthy way to run an economy. But in recent years, Republicans have started to balk
at raising the debt ceiling, causing legislative standoffs. More than once, the US has come within
days of defaulting on its debt - which could cause financial earthquakes throughout the world. The
US is seen as one of the bulwarks of the global economy, and if its debts can’t be counted on,
it would likely have a lot of people rethinking their financial portfolios.
But hey, at least they’re better off than Steak & Ale.
Watch “What If The US Paid Off Its Debt” for an unlikely hypothetical,
or check out this video instead!