Sovereign debt

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Why is sovereign debt a transnational issue?
Explicate austerity and default available to debtor nations and extrapolate the implications for debtors and creditors.

Sovereign debt is the debt that countries owe to private bankers or, possibly, other governments. High levels of debt can radically alter the behavior of investors, raise interest rates and increase competition for loans. State borrowing is necessary for economic growth and therefore, the lack of state spending will harm it. States are not able to respond to crises while carrying debt, and may be forced to cut social programs in response.

Debt is by definition a transnational issue, since debt owed by countries is always to a consortium of domestic and foreign bankers. High levels of debt in one country spillover into the economic performance of its neighbors. As austerity measures are imposed on states with high rates of debt, their economies get worse and debt rises.

The first response to large levels of debt is austerity. This gives the impression that the state is getting its house in order and hence, is a reliable business partner. It seeks, most of all, large cuts in state spending to bring down debt. It often also demands freer-trade laws, permitted foreign capital to invest in the troubled nation.

Another version of austerity might be called "investor coercion." This is a practice where private investors are forced to by state bonds. Governments can require social security funds to be invested in state bonds of various types. External capital flows can also be halted, forcing loans to be taken out domestically. This option is increasingly nonviable, largely because of the increasingly liberal international financial order.

Debt can be restructured. Investors may want to cut a deal where they may take a loss in exchange for the guarantee of some, if not most, of their money back. Restructured debt can lessen the amount owed, lower the rate, or extend the repayment schedule. Of course, central banks can merely print more money, hence lowering its value. When that occurs, the value of the debt goes down, but at the expense of everything else.

What does this mean for debtors? Several things are immediately obvious. First, that it puts the debtor in the position of suppliant. This may differ in the US, where the massive public sector debt is matched by the world's largest market. Pulling out of the US market is just not an option. Yet, for smaller states, coming under the control of the IMF or other private banks is a real possibility (Nelson, 2013).

For debtor countries, high debt often means economic slowdowns and inflation. Several options present themselves. First, states deep in debt can avoid action altogether, permitting market forces to work. This means that the state's role is to permit contracts to function as normal. This is not too different from restructuring. It balances the bargaining power of all parties involved, and permits a great degree of freedom of negotiation.

Second, economic growth can be promoted. Yet, the problems of ...