Sovereign default occurs when a nation can't pay its bills or its debt obligations. This makes it technically bankrupt.
Investors often worry about the risk of sovereign default when central government debt loads around the world rise. Many fear a replay of the 2007-2008 financial crisis, the 2009-2011 eurozone debt crisis, and the ensuing return of a global recession. But defaults are quite common and they may not lead to the worst-case scenario that many expect.
Key Takeaways
- Sovereign defaults happen when a nation can't pay its bills or repay its debt obligations, which technically makes it bankrupt.
- The prospect of sovereign default is scary for investors, but many countries have never defaulted on their debts.
- Ecuador has defaulted 10 times in modern history, and Venezuela has defaulted 11 times.
- The U.S. has never officially defaulted on its debt obligations, although there have historically been instances that could technically qualify as defaults.
- Sometimes sovereign defaults are intentional political or economic moves rather than due to a lack of financial resources.
1. Many Countries Have Never Defaulted
Several countries have a pristine record of paying sovereign debt obligations and have never defaulted in modern times. They include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, and England.
This doesn't mean that these countries skated through 200 years without financial problems. Endemic banking crises were a common occurrence. England has suffered at least eight major banking crises since 1800 and there have been even more by other accounts. Sovereign default isn't the only financial turmoil that a nation can face.
2. PIIGS Are Not Scary
The PIIGS countries are on everyone's watch list as being the most at risk of sovereign default and some of them have been in some pretty hot financial waters. They include Portugal, Italy, Ireland, Greece, and Spain.
But you'll see that these five countries have a mixed historical record of sovereign default over 200 years if you take a longer-term view. Ireland has never defaulted on its obligations and Italy did so only once during a seven-year period during 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, having done so six times, the last being in the 1870s.
Greece has defaulted five times since achieving independence in the 1820s but it hasn't defaulted since then.
Greece did miss itsscheduled 1.5 billion eurospayment to the IMF back in 2015 but both sides called it a delay, not an official default.
3. Latin America Leads Sovereign Defaults
Venezuela and Ecuador shared the dubious honor of 10 defaults each in modern times until Venezuela pulled ahead by defaulting on approximately $60 billion in bond payments in 2017. Brazil, one the fastest-growing of the emerging economies, has defaulted nine times. Costa Rica and Uruguay have disappointed foreign investors nine times over the 200 years.
4. The U.S. Default History
Conventional wisdom says that the United States has never defaulted on its sovereign debt obligations but there have been some instances that may qualify.
The young U.S. Congress passed a law that authorized the issuance of debt to cover the obligations of individual states in the union in 1790. Some of this debt didn't start paying interest until after 1800 so purists may consider this a technical default.
Many issues of U.S. government bonds issued before the 1930s contained a gold clause under which bondholders could demand payment in gold rather than currency. The government couldn't have obliged if they had.
President Roosevelt and Congress realized this in 1933 during the depths of the Great Depression when the thought of citizens swapping paper money for gold wasn't all that crazy. They 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.
The government could not make timely payments on portions of three maturing issues of treasury bills in 1979 due to operational problems in the back office of the Treasury Department. These payments were later made to holders with back interest.
The United States did not default on its debt but Fitch did downgrade the U.S. from an AA+ to AAA credit score in August 2023.
5. China Won't Crack
Another oasis of financial strength is China which has trillions of dollars in reserves and suffered only marginally during the recession. China has defaulted only twice, both times during times of external and internal conflict. The Sixth Division of State-Owned Asset Management did miss a deadline to make a $73 million bond payment in August 2018 but it made it up two days later. 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. Venezuela refused to pay its foreign obligations in 1901. Britain, Germany, and Italy imposed a blockade on Venezuela after negotiations failed to resolve the issue. The conflict escalated quickly and several 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 Venezuela combined its outstanding debt into a new issue after several years of negotiation. It added back interest and made payments until the issue matured in 1930.
7. Strategic Sovereign Default
Some sovereign defaults are intentional and not necessarily due to a lack of financial resources. The new revolutionary government in Russia repudiated all debt issued by the previous Tsarist government in 1918. This state of default officially lasted until 1986 when Russia settled with British holders of the old Imperial paper. An agreement was reached with French bondholders as well in 1997.
What Is the U.S. Debt Ceiling?
The U.S. debt ceiling is the amount that the U.S. government is authorized to borrow to pay obligations that have come due. Failing to raise the debt ceiling is a bit like refusing to repay your credit card bill. The money has already been spent and the debt ceiling authorizes the federal government to pay its bills.
What Happens When a Country Is In Default?
A country is in default when it can't pay its debts. This lowers its credit rating and decreases the cost of its debt. The country's entire economy can suffer and it may see less investment in the future as global investors become wary of buying that country's debt.
Which Country Has Defaulted the Most?
Venezuela became the country that has defaulted on its sovereign debt the greatest number of times in 2017 when it defaulted on about $60 billion in bond payments.
The Bottom Line
Sovereign default is a terrifying thought to many investors, especially given instances of global economic instability and partisan showdowns over the debt limit ceiling in the United States. 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.
Correction—Sept. 3, 2024: This article has been corrected to state that in 1918, Russia repudiated all debt issued by the previous Tsarist government.
