Governments cannot go bankrupt

It’s become trendy to forecast bankruptcy of governments.  While the problem is real, talking about bankruptcy is nonsensical — misunderstanding the nature of the problem.  From Wikipedia

Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a debtor (“involuntary bankruptcy”) in an effort to recoup a portion of what they are owed or initiate a restructuring.

Governments are sovereign.  In the USA States are also sovereign, in a limited sense, under the 11th amendment.  Sovereignty has perks, like the ability to default on debts.  States do not go bankrupt, since no legal entity can declare a State bankrupt and adjudicate its debts.  Creditors only recourses are:

  1. seize assets, usually outside that State
  2. attempt to obtain relief using the State’s internal processes (e.g., suing a State under its own Constitution or laws)
  3. get a bigger State to intervene — the US has used the IMF and US Marines to help powerful creditors collect from small nations

States can default in many ways.  All of these methods have been used many times in both US and world history.

  1. Hard defaults:  such as telling creditors to go away, or making them go away. 
  2. Mild defaults:  such as changing the terms of the loan, maturity of debt, interest rate.
  3. Soft defaults:  such as inflation and devaluation. 

Life goes on after defaults.  Often the consequences are mild (esp compared with the alternatives, such as a depression).  For more about this see “Default settings“, The Economist, 31 March 2010 — “Sovereign defaults do not typically lead to economic catastrophe. How much comfort should that give?”  Default is a symptom of deeper problems.  What matters most happens after default.  Does the nation deal with its problems, or just repeat the cycle (like serial defaulters, like Costa Rica).

For more about defaults see:

  1. America on its way from superpower to banana republic, 28 March 2009
  2. About the coming crisis in public pensions, FM website, 8 January 2010
  3. Would a default by the US government help America?, 21 February 2010
  4. Can Obama turn America into something like Zimbabwe?, 22 February 2010
  5. We might default on our governments’ debt in the future. Do you know how often we’ve done so in the past?, 5 March 2010

Afterword

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