In an era of economic recession, high interest rates and energy shortages, there is talk of an upcoming sovereign debt crisis.
What does that mean?
The modern world runs on credit. That includes nations with bills to pay.
One way that nations fund government is through loans (bonds, bills and debt securities).
All of those debt instruments have an interest rate that the government must pay in exchange for the loan.
For the past 10+ years, interest rates have been very low which means it was very inexpensive to borrow money.
Similar to a credit card with 0% APR, this made it very tempting for governments to spend freely.
However, this free spending era added large quantities of new money into circulation, which contributed to inflation.
To combat inflation, central banks have raised interest rates to slow down issuance of new loans and curb spending.
Separately, there are shortages of food & energy, especially in Europe. The move towards green energy has decreased the supply of available energy, along with the Ukraine conflict.
As most global trade is done in US Dollars, nations need a constant supply of dollars to buy essentials like energy.
This has led the relative value of the dollar to rise, which makes energy and food even more expensive.
This has put many nations into a difficult situation.
The cost of energy has gone up.
The cost of borrowing money has gone up.
Refinancing debt has become more expensive.
When a nation has costs that exceed the available financial resources, they can default on their debt.
It’s similar to maxing out a credit card and not having enough money for the minimum payment.
What happens when a nation defaults?
This is called sovereign debt default, and can lead to several difficult situations for citizens.
Food & energy shortages are common as there isn’t enough money to buy commodities.
This obviously makes people very stressed and upset, so riots and protests can follow.
Governments may be overthrown which creates more disruptions for citizens (healthy economies like stability).
Extreme shortages can drive up prices which could cause a currency to collapse.
Some countries like the United States are unlikely to default because as issuer of the global reserve currency, the US can print more dollars.
Other nations can’t print Dollars so there isn’t an easy solution to defaulting on debt.
The IMF and World Bank sometimes offer bailouts, but there is no such thing as free money in that situation.
There are strings attached that can force a desperate nation to compromise and accept unfavorable terms.
If a large group of nations all defaulted at the same time, this could easily throw the global economy and supply chain into chaos.
A sovereign debt crisis would be a very difficult situation for the world, and could be the spark used to usher in a new financial system with different rules.