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It seems that every country on Earth is in debt, but nowhere on the news do they ever mention to who. If countries are all in debt to each other then why not just cancel all the countries debt.

If it's one central place why don't all countries just refuse to pay it back and cancel the debt themselves, it would mean one place would have huge issues but we can just ignore that and just let them whither away, wouldn't it be better than having all these countries in debt?

Also why is it considered important (important enough to have cuts) to try and get rid of a countries debt? Surely it's not that bigger deal as if a country doesn't repay your hardly going to have someone repossess a country (especially when that country has it's own law and military)?

  • Why are good questions always closed? That must be a tough bot to write. – Simon Kuang Aug 3 '14 at 1:46
  • It's not like it makes any difference, as the question already has been answered well. But here the site name is poor (especially now with the new logo) as I read it as personal finance and money, not personal finance and personal money. – Jonathan. Aug 3 '14 at 13:01
21

"It's more complicated than that."

Governments raise money in a number of ways. First, they tax economic activity within their borders and for connected companies and individuals. Then, some governments have actual revenues from state-owned enterprises (licences, patents, courts, business revenues, and so on).

Whatever shortage arises between state expenditure and this income is the deficit which is usually financed through debt.

Government usually issues a bond (Wikipedia for a list of government bonds) of various types, some with extremely lengthy maturation dates. These bonds can be purchased both locally and by foreign investment funds. The nature of who buys is important.

From the Wikipedia link you'll see that most government debt is very highly rated based on the ability of the state to simply raise taxes in order to fund redemption. Pension funds are legally bound to only invest in highly-rated investment classes and the bulk of bonds may be purchased to support local pensioners.

A state that defaults on debt will first hit its own most vulnerable citizens. In addition, the fall-out will result in a savage cut in ratings. Countries like Argentina and Zimbabwe, which have both refused to repay their debts even to the IMF, are currently unable to raise investment at all. This has a tremendous impact on local economic development.

So, default is out of the question without severe penalties.

The second part of your question is about paying down the debt. As debts increase, more and more of the revenue that a country does earn is spent on servicing debt repayments. Sometimes bonds are issued merely to refinance old debt. A country that spends too much on refinancing debt is no different from an individual. Less and less money is available to do other things.

In conclusion: governments can neither default nor binge-borrow unless they wish to severely limit economic opportunities for their citizens.

  • +1 Great answer. An additional answer to the second part: if the debt increases too much, the government's bond rating could be lowered, which makes future borrowing more expensive and/or more difficult. – bstpierre Sep 22 '10 at 19:44
  • Yes, good point, a lower rating leads to great costs since the government has to offer a better rate of return to cover the increased risk. – Turukawa Sep 22 '10 at 20:35
  • While default is not good. It does not immediate hit its most vulnerable. Assuming it has some money just not enough to cover all its debts it could start by cutting off discretionay expenses. It just makes better political capitol to use the weak as a pawn. – user4127 Jul 29 '11 at 17:52
12

Typically the debt is held by individuals, corporations and investment funds, not by other countries. In cases where substantial amounts are held by other countries, those countries are typically not in debt themselves (e.g. China has huge holdings of US Treasuries).

If the debts were all cancelled, then the holders of the debt (as listed above) would lose out badly and the knock-on effects on the economy would be substantial. Also, governments that default tend to find it harder to borrow money again in the future.

5

The answers provided so far as good and informative, but I just thought I'd add one small point...

There are super-national organisations that commonly lend to governments, in particular those in the developing the world. The World Bank and IMF (International Monetary Fund) are the two primary ones. Also quite notably, the Greek economy was bailed out only this year by the EMF (European Monetary Fund) spearheaded by Germany - this is a rare occurrence however and was done mainly because Greece was a relatively developed country and others had an obligation to assist it as an EU member state.

  • 2
    "an obligation to assist it as an EU member state" - more like a fear of the consequences if they didn't! (losses on the debt damaging their own banks; the potential "domino effect" on other countries; a Greek exit from the Euro showing that the currency is not invulnerable). – GS - Apologise to Monica Sep 22 '10 at 20:12
  • 1
    @Ganesh: That's an obligation in my mind! There's a codified obligation to, if I'm not right, but I'm no lawyer. No doubt, the German and French economies would be hugely hurt if Greece went belly up, as would most other sizable economies in the world. – Noldorin Sep 22 '10 at 21:37
4

Sovereign states borrow money explicitly in a two primary ways:

  • General Obligations: These are bonds (long term) or notes (short term), usually sold on the open market, which pay interest over a period of time. They are backed by the faith and credit of the sovereign, and are not backed by a security such as property.
  • Revenue Obligations: These are bonds or other securities which are backed by specific sources of government revenue. For example, a city may issue revenue bonds to build a bridge -- those bonds are secured by the toll revenue from the bridge. Revenue bonds are usually found in municipal governments.

A sovereign cannot be compelled to repay debt, and there isn't a judicial process like bankruptcy to erase debt. When sovereigns default, they negotiate new terms with creditors and pay back some fraction of the actual debt owed.

They can also print money to repay debt, which has other nasty consequences.

But, while a state cannot be compelled to repay a debt, creditors cannot be compelled to loan money to the state either! Any enterprise of sufficient size needs access to capital via loans to meet daily obligations in anticipation of revenue -- even when times are good. Defaulting makes borrowing impossible or expensive, and is avoided.

Regarding using your military to avoid repaying debt... remember what Napoleon said: "An army travels on its stomach". Military campaigns are expensive... no borrowing ability means the soldiers don't get paid and the food, fuel and ammo don't get delivered.

Smaller countries have other risks as well. Many nations are essentially forced to use US Dollars as a reserve currency, or are forced by the market to borrow money in a foreign currency. This creates a situation where any risk of non-payment results in a deep devaluation of the local currency. When your debt is denominated in dollars, these shifts can dramatically increase your debt obligations from a local currency point of view. You also run the risk that a larger or richer company will park warships in your harbor and seize assets as payment -- the US and Britain engaged in this several times during the 19th and 20th centuries.

In general, not paying the bills has a cascading effect. Bad situations get worse, and they do so quickly.

  • should America decide to not pay it's debt back, what is anyone going to do? Why should not paying you debt back mean there's not enough to spend on soldiers/ Surely if your not paying debt then there's more to spend on soliders. Other countries could refuse to trade with America, but then they are trading in the first place because they need it so there'd be no point in stopping. Also the military would only be there to prevent the people America owe from taking assets/etc. My point being surely it would just better that a few companys/individuals have problems, than every country be in debt. – Jonathan. Sep 24 '10 at 16:37
  • Many countries can simply not afford to pay back debts so the people they owe aren't going to get their money back any time soon so why not just cancel the debt, instead of forcing the country to reduce the quality of life for it's people. Apparently Iceland owe Britain a lot of money which we lent them to help them, but now they refuse to pay back, so why should we. – Jonathan. Sep 24 '10 at 16:39
  • Like I said in my answer, countries that cannot afford to repay can default. Just as in your personal life, defaulting on your obligations has unpleasant consequences. – duffbeer703 Sep 24 '10 at 22:51
  • "creditors cannot be compelled to loan money to the state either" there have been things like forced loans, [see here for an example]( articles.latimes.com/2009/oct/31/business/fi-state-tax31) – cbeleites supports Monica Mar 27 '13 at 23:24
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There no legal framework that allows states like the US or countries in Europe to default on their debt. Should congress pass a law to default the US supreme court is likely to nullify the law.

-1

Depends on the country, whether its a currency issuer with floating exchange rate, and what the debt is denominated in. For instance, the US has no real debt, b/c its all in US dollars and can be printed at any time. It has no need to borrow anything, it issues its own currency. It used to be different 4 decades ago, on the gold standard, so in general people still think currency issuers need to borrow (or earn) to spend. Just a relic in thinking.

But when the country does not issue its own currency, then it does need to earn or borrow in order to spend. In this case, it could borrow from anywhere that will lend it money. In US, a state would fit this description. Or Greece, as it borrowed Euros, for which it is not an issuer of.

EDIT: just came across this blog http://pragcap.com/where-does-the-money-come-from Its title, "Where does the money come from". Maybe he saw this question. Anyway, the US does not need to borrow money. Why would it borrow what it creates?

From the video: "Thinking is hard, that's why we don't do it a lot". Great line.

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    Really because everyone is going on about the $14 trillion debt the US has? – Jonathan. Aug 2 '11 at 18:27
  • Huh? Not sure what you're point is. Why is everyone going on about the US debt? – Andy Wiesendanger Aug 2 '11 at 18:45
  • I think the point is the U.S. does borrow money. The U.S. does not simply print dollars at any time they need money. – Chris W. Rea Aug 2 '11 at 18:59
  • Something about a deadline to raise the amount the US can be in debt, and the fact that is $14 trillion, then theres the politicians arguing over the best way to reduce it. I live in England and have heard all this, I find it strange you, an American, don't. google.co.uk/… – Jonathan. Aug 2 '11 at 19:02
  • I've heard of it Jonathan, and its a waste of time. – Andy Wiesendanger Aug 2 '11 at 19:28

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