eli5 Why it’s bad for country to default on it’s debt?


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.