How does a country go bankrupt?


So currently when someone is mentioning that the European Central Bank should raise interest rates, a counter argument is that some southern countries (Greece, Italy, Spain?) would go bankrupt because they are indebted.

What does “going bankrupt” even mean in that context? Like how can a country go bankrupt and what happens if it does? I don’t really get the concept.

In: 3

It can’t pay its debts. Countries take on lots of debt through bond sales. They have to pay interest on the bonds.

This is ELI5. The basic problem is spending more money than you are bringing in. If you do it for a long time, one of two things happens. Let’s see what:

The country’s gov’t wants to be nice and give every one bread and circuses.

It doesn’t have enough money from taxes to pay for everything they want to give away, so the gov’t borrows the money. Now, the gov’t not only has to pay for all the bread and all the circuses, they have to pay the interest on them as well. That begins to add up.

If the gov’t keeps on spending more than it brings in, eventually, the cost of interest (“the debt burden”) becomes significant. Here are some examples:

US $345 billion, 5.3% of gov’t spending
Can $23 billion, 8% of gov’t spending
Italy $50 billion, 7.6% of gov’t spending

Now, that’s with the very low interest rates of the last few years. If interest rates went from 1% to 2% – hardly a historic rise – those numbers would increase, and gov’ts would have to spend even more money on the interest payments, instead of bread and circuses. So some of them end up borrowing even more, and get into a hyper-inflationary cycle.

History gives many examples of governments that went down this way, from Weimar Germany in the 1920’s, Hungary in the 1940’s, and Zimbabwe in the early 2000’s. the value of their currency collapsed. There’s a popular photo of a German with a wheelbarrow full of cash in the 20’s; there’s another of a 20 trillion dollar Zimbabwe note. Hyperinflation is one bad ending from spending more than you take in.

Going bankrupt is the other way out. Instead of inflating your money to worthlessness, you bite the bullet, declare bankruptcy, and make some settlement with your creditors – perhaps you pay half the principal back, say. Whatever, your new arrangements now fit your circumstances, and you are no longer spending more than you take in. (For gov’t, this usually means “an austerity program” of less bread, and fewer circuses.) Whether this is more or less painful than the hyperinflationary collapse is debatable.