What Happens to A Country When it Goes Bankrupt - YouTube

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!