Legal News

29-Sep-2022

Truths About Effective Sovereign Bankruptcy You Must Know

If there’s one thing that made the global financial crisis more terrifying, it’s the knowledge that even the most financially secure countries aren’t immune to bankruptcy. In 2009, Iceland – until then considered one of the wealthiest and most stable nations on Earth – declared a moratorium on its repayments to foreign creditors, citing its inability to pay as a result of the country’s financial collapse. If you live in America, you might think no such thing could ever happen here. After all, we have a Constitution that protects our fundamental rights and freedoms as citizens; we have an independent judiciary committed to upholding those rights; we have safeguards in place to protect us from economic hardship, and we have a government composed of elected officials who represent our interests above their gain. Unfortunately, history has proven again and again that even the strongest governments can fall victim to corruption and greed. That’s why Americans need to understand exactly what sovereign bankruptcy means so they can make informed decisions regarding where they invest their money and other assets during these turbulent times.

What is Sovereign Bankruptcy?

Sovereign bankruptcy is the process through which a government is declared unable to pay its debts and therefore defaults on its financial obligations. Although sovereign bankruptcy is not as well known as personal bankruptcy, it is nonetheless a very real and very common occurrence. Unlike personal bankruptcy, which is rooted in the individual level, sovereign bankruptcy is an action that can only be taken by a government. The majority of countries around the world have no protection from bankruptcy and have to declare national bankruptcy through a process called restructuring when they are unable to pay their debts. Sovereign bankruptcy is not a decision that is taken lightly since it has wide-ranging implications for the global economy and its citizens. Once a government has declared bankruptcy, the future of that government is heavily influenced by its creditors.

What Causes a Government to Go Bankrupt?

There are several reasons why a government may find itself unable to pay its debt obligations. For example, a government may be hit by an economic crisis that significantly reduces its revenue. In this case, the government may be unable to collect enough taxes to cover its spending obligations. Other times, a government may issue debt to fund projects that don’t produce enough revenue to cover the interest payments. When these scenarios play out, the government must decide whether to raise taxes, reduce spending, or try to raise more money by issuing more debt. Unfortunately, these are all poor options for the government because they have far-reaching negative consequences for the population as a whole. Raising taxes will reduce consumer spending and slow down economic growth. Cutting spending also hurts the economy. And issuing more debt creates a potential future crisis because the government will have to repay that money with interest. And the more debt the government issues, the more interest it has to pay. This comes out of the budget, which means that other expenditures, such as funding programs, have to be reduced to make room for the debt service. And in the long term, the more the government borrows, the greater the risk of a debt crisis. When the U.S. government borrows too much, it makes our country less desirable for investment both at home and abroad which can create a vicious cycle of even higher borrowing.

The Aftermath of a Sovereign Bankruptcy Declaration

When a government declares bankruptcy, its creditworthiness is essentially destroyed. The government is no longer able to issue debt, and those who hold its current debt are unlikely to be repaid in full. As a direct result, investors become much more cautious when dealing with other countries. The very word “bankruptcy” means that the government is unable to pay its debts, and as a result, it is unable to borrow any new money. This makes it harder for the government to fund its operations and address any economic or social problems it may be facing. Moreover, a government that has declared bankruptcy will likely be stigmatized by investors and credit rating agencies. In the worst-case scenario, a government that has defaulted on its debt may find it extremely difficult or impossible to borrow money in the future. This could lead to a situation where the government has no money to pay its bills, which could have serious consequences for the country’s citizens. This will make it difficult for the government to borrow money or to trade with other countries.

How Does Sovereign Bankruptcy Affect the Average Citizen?

When a government has declared bankruptcy, it is often unable to pay all of its citizens what they are owed. This can include pensions, government programs, and even salaries for government employees. When a government declares bankruptcy, it is often met with a mix of panic and confusion. How does a country go bankrupt? What does it mean for the citizens? What happens next? For many countries, these questions are unfortunately answered when the International Monetary Fund (IMF) steps in. This can go both ways, with some creditors getting less than they are owed and some citizens receiving less in government services than they are entitled to. One way this can happen is through the restructuring process. When a government declares bankruptcy, it often enters into negotiations with its creditors to try to work out a deal that is fair to both sides. During the restructuring, the government may try to reduce its debts by offering creditors reduced payments, extended terms, or some combination of the two. In many cases, the government’s creditors are foreign investors that hold government-issued bonds.

Should You Be Concerned about a Sovereign Bankruptcy in America?

Although it is unlikely that the United States government will declare bankruptcy any time soon, there are plenty of signs to indicate that the country is currently experiencing serious economic distress. America’s national debt is currently over $21 trillion, and it is on track to reach $33 trillion by 2028 unless drastic measures are taken. Furthermore, the country’s budget deficit is currently more than $900 billion, and this number is expected to increase over the next decade. Moreover, the United States has a negative Credit Watch outlook with all three of the major bond rating agencies. And although President Biden has promised to reduce the national debt, his proposed budget would increase it by $16.1 trillion over the next decade.

Conclusion

The global financial crisis of the late 2000s was a painful reminder that even the most stable and wealthy nations can find themselves in dire financial straits. Financial meltdowns can happen anywhere, and the best way to guard against them is to diversify your wealth. Even those who are well off enough to weather a financial crisis without significant damage can benefit from diversifying their wealth. Diversification is one of the most important rules of investing, and it’s especially important during high-risk times like these. When this happens, it has serious consequences for the government and its citizens. Sovereign bankruptcy can result in significant reductions in government services and unpaid debts owed to investors and citizens. Fortunately, the United States is unlikely to face sovereign bankruptcy shortly. However, it is still important for citizens to remain informed about the state of the country’s economy and the potential financial pitfalls that lie ahead.