Default: types, causes and consequences

Default is the refusal or inability of a company/country to pay its foreign debt. But it does not yet mean 100% bankruptcy.

CONTENTS:

1) Definition of default.
2) Types of default.
3) Causes of default.
4) Consequences.
5) History of country defaults.

1) Definition of default.

Default (from Default) is the refusal or inability of a company/country to pay its foreign debt. But it does not mean 100% bankruptcy.

Default on a loan is characterized by a number of violations of the borrower’s obligations:

  1. Failure to pay interest on the loan.
  2. Failure to pay the debt.
  3. Other payment obligations, if any.

Default can occur for individuals, businesses, and countries. Any borrower can default for one reason or another.

2) Types of defaults.

There are three types of default (the first two for individuals and businesses:

  • Technical.
  • Debt service.
  • Sovereign.

1. Technical default (from “technical default”) is a default on a breach of payment or some kind of contract.

A technical default does not mean that the issuer is unable to pay. The fact that he does not pay, as prescribed in the contract, could be caused by various circumstances which are not even hinged on him.

For example, wage delays, ATMs not working, loss of passport, and other difficulties that prevented him from paying the debt on time. In any of these cases, the borrower has temporary difficulties that violate the terms of the loan agreement, but do not make him bankrupt.

2. Debt Service Default. This is the borrower’s inability to pay debts because there are no funds available. In this case, the lender’s property is foreclosed: real estate, car, furniture, jewelry, and more. In simple language, this kind of means bankruptcy.

In the case of an individual, everything is resolved through the court. If the state declares default, such an issue is resolved at the international level. Most likely, the debt will be forgiven or postponed for a while. But they will have to pay a heavy price in exchange.

3. Sovereign default is a refusal to pay obligations. This type applies only to states.

More often than not, the country has to deal with the international monetary fund (IMF), which sets certain rules. Rejection of debt does not bode well for the borrower.

An example is Greece, when it declared a technical default in July 1, 2015. The IMF decided to issue a new tranche to bail that country out.

3) Causes of defaults.

It does not make sense to consider what are the causes of default of an individual or a company, because there can be too many options. So let’s look at the causes of default for states only.

  1. The amount of expenditure greatly exceeds the income. Naturally, the country will owe more and more each year. Someday it will not even be able to pay the interest on a loan. An example is the U.S., whose national debt has long ago reached simply astronomical levels and is growing further.
  2. The change of power. The new government can bring in a new course of economic development. Other strong shocks in the country are also possible.
  3. Lower budget revenues.
  4. Wars.
  5. Sanctions.

With the manipulation of the fear of death and the giving away/taking away of money (the resource for life), it is always the minority who control the majority. Introducing modern technology into this process will give total control to all.

4) The consequences of default on the state.

A default does not bode well for the state in the years to come. Russians remember the recent experience 20 years ago – August 1998.

What are the consequences of defaults that are typical of states

  1. A drop in the country’s credit rating. And for a very long time. This means a complete absence of investment in such an economy, no desire to lend it, and if they do give a loan, then only with a high interest rate. Credit rating – this is an assessment of the rating agency of the country or company to fulfill its obligations under the loan.
  2. Severe inflation, falling incomes. Ordinary citizens are getting very poor.
  3. Demographic crisis. Due to increased poverty, the birth rate falls.
  4. Depreciation of the national currency. The country has to take money from somewhere to fulfill budgetary obligations. By devaluing its currency, it manages to close budget holes at the expense of the population. Devaluation (from “DeValeo”, “De” – decrease, “Valeo” – price) is a decrease in the exchange rate (depreciation) of a national currency to a hard currency (the dollar).
  5. A decline in the economy (GDP). Nobody buys anything, because there is no money. No new businesses are opening, because credit has become expensive, and in general at such times it is usually thought about something else.
  6. Crime and corruption begin to develop. Citizens who are prone to theft begin to rob, take away money.
  7. Higher taxes on profits and excise duties.

On the other hand, a default allows a complete reboot of the country’s economy. It is usually followed by a revival of the economy and business in a couple of years.

There have been so many defaults throughout history that entire books could be written about them. These situations were especially common in ancient times, when the economy was poorly developed. And often the refusal to pay was simply due to reluctance, not lack of opportunity. The bigger and stronger your army, the more influence you could have on neighboring countries, and thus it was possible not to pay your debt.

5) The history of national defaults.

The last known case that many of us should remember is 1998, Russia and Ukraine.

Sometimes the mistakes we scored in the past remind us of ourselves in the present.

The surge in defaults came in the 1990s. As many as 12 countries declared their insolvency: Angola (1992-1997), Argentina and Brazil (1986-1990), Venezuela (1995-1998), Croatia (1993-1996), Sri Lanka (1996).

Whereas in the past countries simply refused to pay, now more often than not they resort to devaluing their national currencies. Argentina did so in 1991, Mexico in 1994, Indonesia and South Korea in 1997.

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