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Thursday, 15 February 2018

Deficits, Losses, and (Government) Debt

"The failure to address our long-term fiscal situation has increased the national debt to over $20tn. This situation is unsustainable and represents a dire threat to our economic and national security." These recent words were expressed by Dan Coats, U.S. Director of National Intelligence, to the Senate intelligence committee (FT).

My recent blogs on Every 10 year a new US recession and The drivers of an asset bubble and a recession did not address the potential impact of (government) debt.

In order to visualize its impact, I prepared a diagram comparing the main actors: (Central) Banks, Consumers, Companies, Courts, and Governments.

This diagram shows that the comparison is different in its final stages. From a narrow legal sense, a country cannot go bankrupt while defaulting on its debts.

A country or sovereign default might be considered rare but is certainly not unusual. The Wikipedia list on sovereign debt crises mentions 6 sovereign defaults for USA, including the 1971 Nixon Shock.

Daily Sabah: "Although not commonly known, the U.S. has declared bankruptcy five times, since its foundation. Once it could not pay its foreign debts, and four times could it not pay its internal debts. These bankruptcies had resulted from financial crises in the banking sector, the first of which was in 1790, and the last of which was in 1933." 

A sovereign debt crises includes: (i) a sovereign default, where a government suspends debt repayments, (ii) a debt restructuring plan, where the government agrees with other countries, or unilaterally reduces its debt repayments, and (iii) assistance from the International Monetary Fund or another international source (Wiki).

In the absence of (ii) government debt restructuring, and/or (iii) IMF assistance, a country will usually face hyperinflation (eg, Brazil, Venezuela, Zimbabwe). 

National laws on consumer and/or company bankruptcies will usually differ. Some countries may offer consumers a debt write-off and thus a second chance in life. Company bankruptcies usually end in a legal limbo because termination often requires settlement of all remaining debts.

Money, Money, Money (1976) by ABBA - artists, lyrics, videoWiki-1, Wiki-2