Almost every country has a debt to any other country. a recent report published by a newsgroup said that all countries are indebted to each other. There can be multiple reasons for this, and we will discuss them later.

Why does a country buy the debt of another country?

 

One reason is that it helps to maintain the balance or equality transaction and the reason for doing so is to stabilize the currency and the economy of each other. Suppose country A experiences a currency devaluation. Country A also has reserves in its bank. These reserves are saved so that they can support the currency in difficult times. Country B will buy those reserves from Country B and pay them currency for it. As a result, the currency of country A strengthens. It helps both the countries in progressing and develops a sense of friendship and professionalism between the two countries.

 

 

 

 

Understanding the concept of buying the debt of a country can be difficult and complex, so I will explain it using a simple example. Let us take the example of the United States of America and the republic of china. Although these countries are enemies of each other, they do carry out trade and buy debts of each other. Let me tell you an interesting fact about the United States of America. Did you know that the United States of America must pay a debt of one trillion dollars to china? Shocking right? I will explain this later.

 

The Chinese leadership is smart, and they take full advantage of the country they deal with. Suppose the republic of china sells goods worth one hundred dollars to the United States of America, and in return, the United States pays the republic of china in dollars. It means that China is selling its goods and acquiring dollars from the United States of America.  If China stops selling its goods to the United States of America, its supply of dollars will increase. But how is this possible?

 

When the republic of china stops selling goods, the economy of the united states of America will go down and as a result, the currency of china will become stronger than the currency of the USA. As a result, the United States of America has to pay more and more dollars to pay for the interest on the loans provided to them by China. Moreover, when china stops selling its goods for some time, its market demand will drastically decrease as the goods are vital for the USA. When market demand increases, the price of goods also increases, and as a result, the republic of china will receive more dollars. Moreover, the USA will face another problem too. When the dollar becomes weaker, the prices of American goods go down, so china pays fewer dollars to acquire the goods made in the United States of America.

 

It can be destructive for America and, in some cases, for the republic of china too. It may also lead to the USA going bankrupt and lose its value in the central market. As a result, china buys the debt of the United States of America. The dollars used by china in buying the debt of the USA are earned from carrying out trade with the USA.

 

I can further simplify this. A person goes to a market and keeps on buying groceries from there, a time will come when he has no money left to buy goods from the store. The store owner then loans some money to the customer can continue buying the goods from the store. The stores earn money by selling their goods to you, and part of the money earned is loaned to you so that you can continue buying the goods.

 

You must be wondering that the country that buys the debt will go into constant loss, but that is not true. These countries buy debt for one reason, and that is the economic benefit of their own. But how is that possible when they keep on giving loans to the opposing party. I will explain this using the example of the USA and China. When china loans its money to the USA, it is helping it in buying Chinese goods. The loan given to the USA is given on interest. So, china benefits by selling their goods to the USA and receive yearly payments of loans with interest.

 

Moreover, it strengthens moral relations. I will explain this with an example. There are two countries, country A and country B. country A is going through a hard time, so country B will come forward and help them. If later country B faces problems, country A will come forward to help. This way, their moral relations develop, and they keep on helping each other in hard times such as war or economic constraints.

Moreover, the main point is that Country A will buy the debt of country B just so that it can keep it is currency low, and the country that is facing financial problems should keep on buying the goods of the other country. So, buying the countries debt will benefit both the countries.

 

Moreover, a country buys other countries debt because it helps the economy and currency of the country that is buying the debt. For instance, the united states of America are drowning in debt, and its economy is falling, and China comes to the rescue and buys the debt from the USA. The USA has a strong currency, and the dollar is used in the international buying and selling of goods. As a result, when China buys US debt, they receive dollars. The more the country has dollars, the more their currency is stable in the international market.

 

Moreover, there are other benefits of buying the debts of other countries. Countries with stable economies such as China or the United States of America buy the debts of countries that are drowning in debt. Moreover, these countries are small, or their economy is feeble and can collapse anytime if their debts are not bought. As a result, a country with a stable economy buys the debt of these countries. But this debt must be paid back too but on many flexible terms. However, if these countries are not able to give back the debt, they must privatize their state asset to ask for more loans. If the country does not return this loan, they will have to hand over that organization permanently to the country.

 

An example of this is the deal between China and Sri Lanka. China bought Sri Lanka debt, and in return, Sri Lanka had to privatize their port to return the debt loans to china. They were not able to pay back that loan, so china legally took over that port and is profiting from it.

Consequences of not paying back debt:

 

Most countries are poor, and they are not able to pay back the debt. As a result, they will have to face the consequences of not paying back the debt to the countries. The next step is that they inform their courts about the situation and file for bankruptcy. After that, the court handles all the matters. If a deal is struck between the countries, well and good but if nothing much happens, then the state has only one option left. They liquidate their state assets and turn them into currency. This currency is used to pay back the debts of other countries.

 

Moreover, when the court defaults, the country that has lent the money does not have anywhere to go. They cannot approach the international courts too. Moreover, if a condition for non-payment of debt was not agreed upon while signing the loan contract, the lenders cannot forcibly take over the assets of the other country.

 

There is always a risk of non-payment of debts when the lenders provide loan to the countries, but why do they do it when there is a risk. One reason is that they want to profit from that country, and the other reason is that the country they loan money to has a good reputation in the financial market. Their reputation is also up to the standard when they pay back loans to other countries. The united states of America have never defaulted on their debts and that is why they easily acquire loans from other countries. Their terms of payment are also flexible than countries such as Argentina or Venezuela who have defaulted in the past. There are chances that they will default in the future also.

 

Another consequence of not paying back is isolation. These countries will have no access to credit from international bond markets. Countries are in constant need of credit as it helps in boosting their growth. If the credit is cut off, their economic progress will become stagnant, and they would be left behind by other countries. Due to this reason, most countries repay the debt even if they have defaulted. Moreover, 100 percent credit is not cut off as countries do pay back debt, not fully, but partially. It means that they can get a partial repayment and in return, such countries are not cut off from credits.

Should we shift to a country drowning in debt?

 

It is not a good idea if you are deciding to shift to a country that is drowning in debt as it has many side effects. Some of those effects are:

The rise in interest rates:

 

Whenever a country has a debt to pay and it is unable to do so, the interest rates rise in the country. It rises in the international bond market first, and the after-effects cause interest rates to rise inside the country too. It means that the government itself is borrowing loans from the international markets, and as a result, the corporates are also forced to buy loans at a higher interest rate. It raises the interest rates, and it affects the prize bonds bought by the government earlier. The value of these prize bonds decreases even more. Higher interest rates affect trade and commerce too. Well, trading requires money too, and that money is borrowed from the banks.

 

If the bank sees that a country has higher interest rates, it will refrain from providing loans. As result, countries will not be able to carry out trading and this will decrease the growth of the country. So, if you plan to go to a country with a bad debt situation and decide to trade there, it won’t be the best place as you might end up losing most of your money.

 

Moreover, if the interest rates are high, doing business will not be a great idea. If you would take a loan from the banks of the country, they will charge very high interest, and this will affect your profit as you will have to pay the interest from the profit you earn.

A decrease in the exchange rate:

 

A plummeting exchange rate is another problem a country faces when it is drowning in debt. When exchange rates decrease, the country falls short of currency notes. As a result, the country has no option but to print notes. When situations become worse, the country reaches a point called hyperinflation.

What is hyperinflation? I will explain it in the simplest words possible. Country A has a good economic situation and is clearing its debts on time. Country B has a bad economic situation, and it fails to give back its debts on time.  Country B is clearly at a stage and is more likely to reach hyperinflation.

 

Hyperinflation is reached when a country starts printing more currency notes than required to curb the economic situation, but it does not help. Country B faces hyperinflation, and country A does not face hyperinflation, as a result, the number of notes in country B will be higher. If you go to a supermarket, it will take you 10 dollars to buy a loaf of bread in country A, but if you live in country B, you will have to pay, for example, 10 thousand dollars for buying bread.

 

As a result, international investors refrain from investing in that country. Moreover, the value further decreases as people start to sell the local currency notes in exchange for much stable currency notes.

Countries that do not depend on international investments do not face such types of situations. But in most cases, countries that owe debt have also made investments in those countries.

 

Moreover, if you shift to a country that has lower exchange rates, you will have to carry out bundles of money just to buy a pen for your daughter. Moreover, you might not be able to establish a business in that country.

The decrease in employment opportunities:

 

Debts bring negative effects to the country, and an increase in unemployment is one of them.

Every country has private companies as well as state-owned organizations.  In these situations, the government is not able to borrow more loans, and the tax revenue is low. As a result, the government fails to pay the salaries of employees, and as a result, they will have to tell them to quit the job.

 

Moreover, private companies also shut down due to higher interest rates. These companies also require debt from the country, and when the country is not able to give them loans, they shut down. It leads to the unemployment of workers.

 

So, you should carefully examine the economic situation of the country before shifting there as you might not be able to find a job there.

Higher prices of goods:

 

With an increase in interests, many economies shut down and this affects the tax collection of the country. As a result, the government applies heavy taxes on goods so that they can increase their tax collection. People stop buying these goods, or they buy cheaper goods. As a result, tax revenue further decreases, and the GDP of the country crashes.  Once GDP crashes, the country goes into defaulter mode, and prices of products reach very high.

Stock market crashes:

 

If you are a stock market investor, you should not shift to countries that are failing to pay back their debts. Stock markets lose around 40 to 50 percent of their total capacity, and you can face losses.

Leave a Reply

About Salient

The Castle
Unit 345
2500 Castle Dr
Manhattan, NY

T: +216 (0)40 3629 4753
E: hello@themenectar.com