National bankruptcy

National bankruptcy (or national insolvency) is the formal declaration of a government to not (repudiation) or only partially pay/meet its debts (due receivables) or the de facto cessation of due payments.

Reasons

The national bankruptcy historically was caused by three reasons:

• insolvency /over-indebtedness of the state
• political motivated refusal to take over the debt of the old administration after a change of government
• ruin /decline of the state

Insolvency /over-indebtedness of the state

If a state for economic reasons defaults on its treasury obligations/is not anymore able to handle its debt/liabilities or to pay the interest on this debt it faces national bankruptcy. To declare insolvency it is sufficient if this state is only able to pay part of its due interest or to clear off only part of the debt.

Reasons for this were mostly:

• a lost war or
• decade-long public budget mismanagement/maladministration

The national bankruptcy caused by insolvency historically always appeared at the end of long years or decades of budget emergency, in which the state has spent more money than it received. This budget balance/margin was covered through new indebtedness with national and foreign citizens, banks and states.

Change of government

While normally the change of government does not change the responsibility of the state to handle treasury obligations created by earlier governments, nevertheless it can be observed that in revolutionary situations and after a regime change the new government questions the legitimacy of the earlier one and thus defaults on this treasury obligations considered Odious debt.

Important examples are:

• default of debts of the Bourbon France after the French Revolution
• default of bonds through Denmark in 1850, which were issued by Government of Holstein instated by the German Confederation
• default of debts of the Czarist Russia after Soviet government came 1917 to power

Decline of the state

With the decline of the state its obligations are turned over to one or several successor states.

Lost wars significantly accelerate national bankruptcies. Nevertheless especially after the Second World War the Government debt has increased significantly in many countries even during long lasting times of peace. While in the beginning debt was quite small the increase due to the Compound interest effect increased it substantially.

Consequences

Creditors of the state as well the economy and the citizens of the state are affected by the national bankruptcy.

Consequences for creditors

The most visible effects of national bankruptcy are the complete or partial loss of lent money and/or interests upon.

In this case very often there are international negotiations which end in a partial debt cancellation (London Agreement on German External Debts 1953) or debt restructuring (e.g. Brady Bonds in the 1980s). This kind of agreement assures the partial repayment when a renunciation / surrender of a big part of the debt is accepted by the creditor. In the case of the Argentine economic crisis (1999–2002) the creditors had to accept the renunciation of up to 75% of the outstanding debts.

For the purpose of debts regulation debts can be distinguished by nationality of creditor (national or international), or by the currency of the debts (own currency or foreign currency) as well as whether the foreign creditors are private or state owned.

Consequences for state

With national bankruptcy the state disposes off its financial obligations/debts towards its creditors. This naturally leads to lower public spending/ a reduction in spending from the public budget to the amount of interest and repayment/redemption.

On the other hand a national bankruptcy always damages the reputation and trust of a state towards the creditors. Hence a state is at least temporarily unable to get new credits from the capital market.

Consequences for the citizen

National bankruptcy always means for the private citizen a dramatic devaluation of his monetary wealth, because the private/individual saver is often an important creditor of the state (e.g. government bonds).

More severe is the impact on the national economy. These comprise typically

• a banking crisis, as banks have to make write downs on credits given to the state.
• an economic crisis, as the interior demand will fall and investors withdraw their money
• a currency crisis as foreign investors avoid this national economy

The citizen feels the impact indirectly through high unemployment and the decrease of state services and benefits.

Preventive measures

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Examples of national bankruptcy

A failure of a nation to meet bond repayments has been seen on many occasions. Perhaps the first was in the 1820s, when several Latin American countries which had recently entered the bond market in London defaulted. These same countries frequently defaulted during the nineteenth century, but the situation was typically rapidly resolved with a renegotiation of loans, including the writing off of some debts.

A failure to meet payments became common again in the late 1920s and 1930s; as protectionism rose and international trade fell, countries with debts denominated in other currencies found it increasingly difficult to meet terms agreed under more favourable economic conditions. For example, in 1932, Chile's scheduled repayments exceeded the nation's total exports.

• Russia 1998 Russian financial crisis
• Argentine Argentine economic crisis (1999–2002)
• Zimbabwe Hyperinflation in Zimbabwe