Sovereign Default Creates Economic Risks for All
A sovereign default is an act of currency default. When a nation’s government fails to make payment of its foreign debts, the U.S. Department of State, in coordination with the Secretary of the Treasury, considers it in a sovereign default – that is, it considers the government no longer able to meet its commitments regarding debt repayment. A sovereign default can come about for a number of reasons. Many nations are facing challenges in meeting their obligations to their creditors and others have run up huge debts.
A sovereign default has serious consequences for both the United States and its creditors. If a country deliberately fails to make its payments, the U.S. Secretary of State will exercise “replaced debt” in accordance with the terms of the Treasuries Act. In essence, the U.S. Treasury will issue a debt that is the “replacement” for any of the outstanding foreign debt held by the government. The debt is then repaid by receiving a lump-sum payment from the country whose currency was used to finance the debts. The amount of a “replacement” debt is limited to the amount that the U.S. Government can obtain from foreign governments in exchange for the total amount of its foreign assets. In cases of sovereign defaults, the U.S. Government may seek to recover some of its invested funds from foreign-owned corporations.
The European Union (EU), led by the UK, has a history of sovereign defaults. The Column argues that some of the EU member states may choose to ignore the problems of underperforming debt holders in order to preserve the euro as a major currency. If this happens, the UK would be forced to either maintain the special European Investment Fund (EIF) or obtain funding from the EU itself for its own sovereign debt needs. Some other EU member states may also decide to ignore the problem of defaulting in order to protect their own banks.
The European Commission itself has criticized the U.S. State department for publicly speculating on the effects of a sovereign default. The EC contends that such speculation is not substantiated by the facts. The EC stated in January that it was studying the possible effects of a Greek Greco-Roman default on both the European Central Bank (ECB) and the Greek sovereign debt. The Commission further stated that it is examining the possibility of default on Greek government bonds with an interest rate exceeding 125% of the nominal gross domestic product (NOMP). This level is considered excessive and in violation of the European creditors’ rights.
The ECB has already refused to guarantee the bonds of the governments of Greece and Italy. If the UK opts to invoke the European Communities’ Structural Adjustment Program (SACR) to restructure its debts, the ECB will lose its right to collect interest payments on Greek government bonds. This would leave the UK with very large sovereign debts and no way to raise funds to service them. A European debt bailout is highly unlikely at this time due to the lack of support from the remaining member states.
The European creditors are also concerned about the viability of remaining within the euro currency area. If the UK were to default on its UK sovereign bonds, the remaining EU countries would be forced to cut off ties with the UK and seek trade relations with the Russian Federation instead. This would mean that the UK’s economic recovery would be much more fragile than it currently is. A prolonged and severe default on UK government bonds would also significantly affect the trading and lending conditions of its major financial creditors.
In addition to the above-mentioned reasons, there are a number of other issues that have been cited as having a bearing on the growing global economic crisis. These include problems in the United States, the European Debt Crisis, Europe’s recession, the housing bubble crisis in the United States, and imbalances in the international portfolio of risks. All these factors have had an effect on global credit conditions and the overall state of the global economy. The imf crisis, high interest rates, currency market volatility, and other potential instabilities have all combined to make the global economic crisis what it is today.
If the UK has decided to opt for a sovereign default, this decision will have a significant impact on the United Kingdom’s economic recovery. In addition to damaging the United Kingdom’s economic recovery, a sovereign default could also severely damage the international image of that country. As a result of this threat, the UK government is currently undergoing a period of consultations with key members of both Houses of Parliament in order to draft a plan for dealing with the sovereign debts crises. The UK government is also planning to present a series of options to the United Kingdom’s creditors for dealing with the current sovereign debt crisis.