There have been at least ten significant sovereign debt defaults from 1983 to 2022, with seven happening in the last decade.
When a national government fails to keep up with the interest payments on its debts, it will be unable to access the debt market for years, and if it can, it will pay higher interest on the debts, reflecting the higher risks of lending to it.
What triggers a sovereign debt default?
A combination of misguided policies leaves investors doubtful whether the country can service its large public deficits as it spends more than it earns, financed primarily by the bond market.
If the country has autonomy over its currency, its central bank creates more currency to buy surplus sovereign bonds.
“There have been at least ten significant sovereign debt defaults from 1983 to 2022, with seven happening in the last decade”
WIN INVESTING
However, the imbalance in the sovereign bond market, where there is an oversupply of bonds to finance the ever-growing public deficit and the waning investor demand, causes the market price for bonds to fall, pushing up corresponding yields.
Rising sovereign bond yields increase the cost for the government to service the public deficit.
So, the central bank enters the market through its open market operations and creates currency to buy surplus bonds, a programme known as quantitative easing QE.
The hidden cost of QE yield targeting bonds below the market rate is currency debasement.
If productivity in the economy remains constant and more currency is chasing the same level of goods and services, households and businesses will need more currency to buy goods, services and inputs.
In this scenario, inflation occurs as the currency’s purchasing power dilutes.
“The hidden cost of QE yield targeting bonds below the market rate is currency debasement”
WIN INVESTING
There is a current debate as to whether price controls can curb inflation. Some argue that forcing businesses to lower costs when there is cost-push inflation due to rising input costs could worsen the problem as aggregate supply is cut further due to businesses closing doors and being unable to make profits.
History has shown price control leads to shortages and scarcity.
Centrally planned economies have failed, as even Communist China and Russia get that.
Fiscal and monetary prudence would curb inflation, as creating currency to finance white elephant projects and endless wars is inflationary.
In our lifetime, we have seen the system, a free market democracy with freedom of expression where price discovery determines markets, transition into central bank-driven markets, freedom of expression suppressed, price control and collapsing living standards where the next generation will live worse than their parents.
We see a totalitarian technocracy ahead as sovereign debt defaults accelerate into a turbulent decade.
“What if the reality of AI is somewhere in the middle, that AI is not BS but finds its way in streamlining business operations?“
– Win Investing
Could AI accelerate future sovereign debt defaults?
In a piece, “AI Mania Bubble,” dated July 1, it was noted that as the technology limitations become evident in real-world applications, the AI bubble would pop.
Those daring who shorted AI’s darling, Nvidia, made money.
But is this an AI price correction or something more?
What if the reality of AI is somewhere in the middle, that AI is not BS but finds its way in streamlining business operations?
Imagine this scenario, where low-level skill, non-creative jobs, more than half the workforce, is replaced by AI technology.
Work participation rates would continue to collapse, and a tsunami of home mortgages would default as a nightmare for banks unfolds.
The Federal government facilitates homeownership by providing guarantees against losses from defaults on mortgages.
So, a treasury bond is a bet on Americans being able to pay their mortgages.
USD reserve currency status provides Americans with Exorbitant Privileges and can run large debts and get away with it.
“All sovereign defaults have in common a failed state doubling down” – Win Investing
The AI fallout could lead to sovereign debt defaults in lower-skilled economies with already large debts and where the currency is already withering on the vine
Who were the ten greatest sovereign debt defaults in history?
1 Greece defaulted on $264.2B in Mar 2012
2 Argentina, $82.3B in Nov 2001
3 Russia, $72.7B, Aug 1998
4 Greece, $41.4B, Dec 2012
5 Lebanon, $31.3B, Mar 2020
6 Venezuela, $31.1B,Nov 2017
7 Argentina, $29.4B, Jul 2014
8 Ecuador, $17.3B, Apr 2020
9 Ukraine, $13.3B, Oct 2015
10 Argentina, $10.5B, Feb 2020
Source: Moody’s
All sovereign defaults have in common a failed state doubling down on failed policies as it collapses on its weight of debt, followed by a currency crisis and a societal collapse as the population plunges into poverty.
Another common factor is all countries experience years of recession,
Greece’s $264.2 billion default in 2012 was the largest to unfold when the country was mired by recession for the fifth consecutive year.
Greece ran significant deficits despite being one of the fastest-growing countries in Europe. Furthermore, in 2009, the newly elected prime minister revealed that the country was $410 billion in debt—substantially more than previous estimates.
Coming second, Argentina failed to repay interest on $82.3 billion in foreign debt in 2001. Like Greece, it is a repeat offender, defaulting numerous times since.
The paradox of the two major sovereign debt defaults is that Argentina was one of the most resource-rich countries in South America, and Greece was the fastest-growing country in Europe
Russia’s 1998 default on $72.7 billion in loans, coincided with a currency crisis that erased more than two-thirds of the Ruble’s value in a few weeks.
The 2020 Lockdowns and collapsing oil prices were a record year for sovereign debt defaults, reaching seven
Moreover, Lebanon, Ecuador, and Argentina saw the greatest defaults amid deepening fiscal pressures.
Sovereign debt defaults underscore that certainty in safe-haven assets does not exist as there is only a level of probability of losing capital
Sovereign bonds are viewed as safe-haven assets, but investors can and have lost money investing in them.
Even treasury bond investors have bond portfolio losses on their portfolio in 2023, underestimated maturity risk adverse effects of inflation on the bond. Overpaying for gold in a bull market can also leave investors holding losses when prices deflate.
A diversification strategy is the holy grail of investing, and the inverse of bonds in terms of performance is gold, as explained in the diversification of ETFs negatively correlated.
