The rise of central government debt loads around the world has gotten investors obsessing once more over the risk of sovereign default, fearing a replay of the 2007-08 financial crisis, the 2009-2011 eurozone debt crisis, and the ensuing return of a global recession. While sovereign defaults—in which a nation can’t pay its bills or debt obligations, making it technically bankrupt—are frightening, they are actually quite common and may not lead to the worst-case scenario that many are expecting. Here are seven facts about sovereign defaults that might surprise you.
1. Many Countries Never Defaulted
There are a number of countries that have a pristine record of paying on sovereign debt obligations and have never defaulted in modern times. These nations include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, and England. But don’t think that these countries skated through the last 200 years without financial problems, because endemic banking crises were a common occurrence. Depending on the definition, England has suffered at least eight major banking crises since 1800. By other accounts, there have been even more. The point is that sovereign default isn’t the only financial turmoil a nation can face.
2. PIIGS Are Not Scary
The PIIGS countries—or Portugal, Italy, Ireland, Greece and Spain—are on everyone’s watch list as being the most in the risk of sovereign default. And yes, some of them have been in some pretty hot financial water in the last decade.
But if you take a longer-term view, you’ll see these five countries have a mixed historical record of sovereign default over the last 200 years, with Ireland never defaulting on its obligations and Italy only once during a seven-year period in World War II. Portugal has defaulted four times on its external debt obligations, with the last occurrence in the early 1890s. Spain holds the dubious record for defaults, as having done so six times, with the last occurrence in the 1870s.
As for Greece—well, it has defaulted five times since achieving independence in the 1820s, or half its modern history. But not since then. Admittedly, it missed its scheduled 1.55 billion euros payment to the IMF back in 2015, but both sides called it a delay, not an official default.
3. Latin America Leads Sovereign Defaults
If you want to worry about where sovereign default might strike next, look to South America and Central America. Venezuela and Ecuador shared the dubious honor of 10 defaults each in modern times until Venezuela pulled ahead by defaulting on approximately $65 billion in bond payments in 2017. Brazil, which today is one the fastest-growing of the emerging economies, has defaulted nine times, while Costa Rica and Uruguay have disappointed foreign investors nine times as well over the last 200 years.
4. The U.S. Default History
Although the conventional wisdom is that the United States has never defaulted on its sovereign debt obligations, there have been some instances that may qualify, using a strict and technical definition.
In 1790, for example, the young U.S. Congress passed a law that authorized the issuance of debt to cover the obligations of individual states in the union. Since some of this new debt didn’t start paying interest until 1800, some purists consider this a technical default.
Many issues of U.S. government bonds issued prior to the 1930s contained a gold clause under which bondholders could demand payment in gold rather than currency. If they had, the government couldn’t have obliged, which means technically it was in default (or would have been, if everyone had ever tried to collect). Realizing this in 1933—the depths of the Great Depression, when the thought of citizens swapping paper money for gold wasn’t all that crazy— President Roosevelt and Congress decided that the promise was against “public policy” and obstructed the “power of the Congress,” so they ended it. The issue was litigated and ended up before the Supreme Court, which ruled in favor of the government.
In 1979, the government could not make timely payments on portions of three maturing issues of treasury bills due to operational problems in the back office of the Treasury Department. These payments were later made to holders with back interest.
5. China Won’t Crack
Another oasis of financial strength today is China, which has trillions of dollars in reserves and suffered only marginally during the recent recession. China has defaulted only twice, both times during times of external and internal conflict. Admittedly, its debt load is increasing, and in August 2018, the Sixth Division of State-Owned Asset Management missed a deadline to make a $73 million bond payment. (It made it up two days later.) Still, the People’s Republic seems to be in solid shape.
6. War Over Sovereign Default
The Western Powers sometimes reacted with military force when a country decided not to pay back money that was borrowed. In 1902, Venezuela refused to pay on its foreign obligations. After negotiations failed to resolve the issue, Britain, Germany, and Italy imposed a blockade on Venezuela. The conflict escalated quickly and a number of Venezuelan ships were sunk or captured, ports were blocked and coastal areas were bombarded by the Europeans.
The U.S. eventually intervened to mediate and after several years of negotiation, Venezuela combined its outstanding debt into a new issue, added back interest and made payments until the issue matured in 1930.
7. Strategic Sovereign Default
Some sovereign defaults are intentional and are not necessarily due to a lack of financial resources. In February 1918, the new revolutionary government in Russia repudiated all debt issued by the previous Tsarist government. This state of default officially lasted until 1986, when Russia settled with British holders of the old Imperial paper. In 1997, an agreement was reached with French bondholders as well.
The Bottom Line
Sovereign default is a terrifying thought to many investors, especially given the recent roller-coaster ride the stock markets have experienced in late 2018 and early 2019. But those who examine the issue more rationally, and in the context of the history of such events, will realize that the global financial system has seen this before and survived.