eli5 Why it’s bad for country to default on it’s debt?
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Well, whether you’re a country or an individual, if you stop paying your debts then others will stop agreeing to loan you things. If you’ve gotten into debt in the first place, then evidently you’re someone who sometimes needs loans. So the next time you need a loan, you’ll be screwed.
When countries borrow money, the amount they have to pay back on top of what they have borrowed (called interest) is determined by a lot of things.
One of the main things is how likely it is that they’re going to be able to pay the money back. If a country defaults on their debt, they will likely find much fewer people will want to lend them money at all, and those who do will demand very high interest rates.
It’s bad for any entity to default on their debt. When you default suddenly you lose any trust that you’re a reliable entity, and the terms of the future debts will be far less favorable and more difficult to obtain future debt. Generally it will be more expensive and have higher interest payments.
Because almost nobody is willing to lend money to someone that has demonstrated they won’t pay it back.
Nations borrow money all the time to accomplish a wide range of projects and services.
A nation’s currency is also backed by trust in its government (normally). Default removes the trust that government and the associated currency. This lack of trust leads to devaluation and hyper-inflation.
Governments issue bonds as investments to lenders. These bonds are issued with stated rates of return. So for example, you may buy a bond from your own state, with an expected rate of return and your state may use the money you’d paid to build some infrastructure. A bond is basically a loan, with interest. You buy the bond, the government uses the money, and later they pay you back with interest.
Bonds are rated in quality. A bond from a government which is very good at paying you back gets good ratings. A bond from a government with poor chance of paying you back gets bad ratings.
So, if a country defaults on its debt, it looks like a guy who can’t pay money back to those who lend to him. It’s like a friend of yours who never pays you back on a personal loan. He’s bankrupt, and stands very little chance of getting another loan from you. His bond is worth nothing, he can’t borrow. He’s a credit risk, so few want to lend him credit to buy or build things.
If I lend you money and you don’t pay me back, I’m going to hesitate to lend you money in the future. And if I do lend you money again, I’m at least going to view it as a more risky loan and charge a higher interest rate. Every country has surprises that require extra money, so even if you don’t regularly run a deficit, you’re going to need extra cash at least occasionally. Defaulting on debt won’t cause your country to collapse, but it does make keeping your country stable more expensive.
Countries often need to borrow money — to pay for stimulus in times of recession, in times of unexpected disasters (COVID, earthquake), or in times of war. Selling bonds is also a tool to reign in inflation. So if a country defaults and investors refuse to lend in the future, that severely hamstrings a government’s ability to control the economy and pay for urgent expenditures.
Outside of the really basic explanation of “because people don’t want to lend money to those who can’t pay it back”, it’s especially bad for a country to default on its debt because a country should be much more able to pay back their debts than your average joe through taxes and bonds and simply printing more money.
If a country is in so much debt that they can’t even meet their debt payments after tapping into the (theoretically) limitless money pile they accrue by taxing their citizens and selling bonds and literally printing more money, then that’s a massive red flag for lenders that the country is either unable or unwilling to do what’s necessary to make their money back.
It’s not so different than if you don’t pay your debt. If you don’t pay back money you owe:
1) people stop loaning you money (buying bonds),
2) people start looking for ways to get that money back (seizing property, charging fees for stuff)
3) people get upset and start to ignore you (not trade, not consider your positions)
… and as a country, it means that the government needs to get more money from its own people (taxation, interest) and can do less because it’s broke.
Imagine you and I are countries. I ask to borrow 10 candy bars today with an agreement that I’ll give you 11 candy bars tomorrow. This is a 10% rate of return. You think I’m trustworthy, you were not going to eat those 10 candy bars anyway and like the idea of ending up with an extra candy bar (profit on your loan). We sign a little contract and I take my candy bars.
The next day you come to me to retrieve the candy bars but I don’t have them. I’ve defaulted. You lost 10 candy bars instead of gaining 1.
Next month again I ask to borrow 10 candy bars. First you say, “get lost” — you refuse to lend me anything because I’ve demonstrated I can’t be trusted. Perhaps I can convince you to lend, but it’s going to be a smaller loan and a higher rate of return. Perhaps you lend me one candy bar but I have to give you three tomorrow for you to accept my terms.
It’s bad to default because you may be refused credit (no one will lend to you) and the rate (aka cost of borrowing) increases dramatically.
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