Eli5: What is a default in the Economy ?


Eli5: What is a default in the Economy ?

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A borrower who is in default borrowed money and they are behind on paying it back. We say they “defaulted” on their debt, or “the debt is in default.”

Countries take out loans and usually this is actually a good thing, so long as there aren’t too many loans and the country is able to pay them back.

(Almost?) every country’s government raises money by allowing others – people, institutions, even other governments – to give it loans which it then promises to pay back. This is on top of other means it has to make money, such as taxes, tariffs, and printing its own money.

The more such loans a country takes out, the more money it has to spend paying interest on those loans. If there isn’t enough money to spend on whatever the government needs to spend it on, then the country can raise taxes or other fees, print more money, or take out even more loans.

Now usually, all of these are preferable to the final option, which is to declare “I’m unable, or unwilling, to pay back the loans I took out”. The government usually has every right to do that. You can write a loan to your government and they can turn around and say “What loan?” but by doing so, they damage their credibility and make it far less likely that anyone will write them a loan in the future.

Sometimes this is unavoidable. For example, the Greek debt crisis of 2007 was caused by Greece borrowing so much money that the nations giving them that money demanded the Greeks reorganize their economy in such a way that they would have a chance of paying it all off. Since so much of the “value” was leaving the country to pay off all that debt, their own economy tanked. Unemployment was high and wages were low meaning that raising taxes wouldn’t be effective, and Greece was using the euro by that point so they couldn’t unilaterally print money like they could if they had their own currency.

Sometimes it is avoidable but the country explicitly chooses to not pay back its loans. In 1918, Russia, having undergone a communist revolution, announced it would not honor the debts that the previous government owed.

In 1998, Russia had transitioned back to capitalism but its economy was flailing with very high levels of unemployment and inflation, meaning that taxes and even more money printing weren’t good choices. Rather than undergo the sort of austerity measures that were forced on Greece by its international creditors, Russia’s legislature (dominated by communists who were very skeptical of foreign agencies like the IMF who would have been writing them the loans) announced that it would default on its foreign debts while doing its best to pay what it owed to Russian creditors. Fortunately, a spike in oil prices in the following years, plus some benefits of a worthless currency (everything is super cheap when you sell your stuff abroad) allowed the country to recover and eventually pay off the remaining loans, restoring foreign creditors’ trust that any loans they wrote to Russia in the future would actually be repaid.

Default is when you don’t pay money you owe when the money is due to be paid. Almost always this is because you *can’t* pay it, like you just don’t have the money.

If you’re reading the news, you might hear them talk about “the US” going into default, and they’re talking about the federal government. They’re talking about fears or the possibility that the US government might not pay the money it owes when those payments come due.

I don’t get it. What currency/money are governments lending to each other if they themselves are the ones that give it value? Why not just print a gajillion dollar bill and call it a day?

Someone just asked about the debt ceiling, so I wrote this, which should answer your question in a round about way.

If we default, the central banks credit score will go down and interest rates will march higher naturally, instead of artificially, which is what the fed has been doing to slow down the growth of the economy.
If you’re wondering why the Fed (US Central Bank) is trying to slow down the growth of the economy it is because inflation is getting higher. So why is inflation getting higher? The reason that inflation is getting higher is because unemployment is at 3%. So what does that mean? When unemployment is at a very low level prices go up. Well, why do prices go up? Prices go up because employers have to pay new employees more money, because there are no employees to fill the jobs because everybody’s already working. Why is that? Well when you pay employees more money, you have to get the money from somewhere so you have to raise the prices of your products or services. When the cost of things go up, that is called inflation. So, in a nutshell, inflation, as we see it right now in the United States, is in line with economic growth. But I thought economic growth was a good thing? Well, economic growth is usually a good thing. Unless you don’t have anybody to fill the jobs, then ya get too big for your britches and that’s when inflation sets in. (Or a bubble, ouch.) So wait you still haven’t explained why the federal governments central bank raises interest rates to slow down growth and how that happens. The easiest way to explain that is to say that if interest rates go up, people stop making big purchases, like automobiles and houses that require loans with interest payments because interest rates are so high.

The difference between the fed raising interest rates artificially, and our government not raising the debt ceiling and the central bank or Fed going into default is that if we go into default it is not artificial. If the central bank goes into default, it would be like you were all defaulting on a loan on a car or a home. everything will go to shit. It wouldn’t slow down the growth of the economy in a conservative in good way like what the Fed is trying to do right now to prevent a bubble. What it would actually do would be it would cause a bubble, better known as a stock market correction. Most people would just say a market collapse, because when a large portion of people lose 30-80% of their retirement, it doesn’t seem like a correction to anyone.

Oh, by the way, a little extra note. If the U.S. markets collapse, historically speaking, all other markets around the world fall like dominoes and we enter a recession/depression. So, the imaginary number that congress makes up that is called a debt ceiling is intended to stifle out of control spending. Everyone knows that when we reach it, there is no other choice but to move it up a few trillion dollars or start to eliminate some of the budget. Here are the top three catalogues which make up more than 3/4 of the budget.

27% Health and Medicare

33% Social Security, Unemployment, Labor

16% Military and Defense