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What is National Bankruptcy?

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  • Written By: Jeany Miller
  • Edited By: O. Wallace
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  • Last Modified Date: 01 November 2016
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Severe economic crises may cause one or several governments to declare national bankruptcy. This is a formal assertion that the government is not sufficiently solvent to pay creditors. Bankruptcy may allow the government to repay some or none of its debts in order to reorganize finances. The International Monetary Fund (IMF) often oversees government bankruptcy procedures and may intervene to prevent such events from happening. Historical occurrences of national bankruptcy have shown to reduce private citizen wealth and tighten government spending.

When a country declares national bankruptcy, the government has determined that it does not have enough money to pay the balances owed to creditors. Depending upon the circumstances, bankruptcy then allows partial or no payments on debts. The accumulation of such debts may be owned by any level of government, including local or central. As most governments draw their revenue from the citizens, this debt is often perceived as indirectly owed by the taxpayers.

A public finance system usually provides money to the government for budget spending. A government does not borrow money in the traditional sense, such as from a bank or other lending institution. Instead, debt may be issued in the form of bills, notes and bonds purchased by citizens. This money is generally repaid with interest to entice purchasers. Such a method of borrowing may be considered internal debt, which is money owed to lenders within a nation.

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External debt, conversely, is owed to foreign lenders. Similar to the way in which bonds or notes may be issued to citizens, governments are likely to issue securities and bills payable to other nations with interest. Countries considered less credit-worthy may need to offer substantial interest rates before other countries will assume the debt. Government spending may also be funded by such taxes as those generated from citizen income, property ownership and merchandise sales.

While a government may impose a ceiling on its fiscal spending, debt may accumulate year after year because of rising costs or insufficient budgets. National bankruptcy is thus often the result of any one or combination of the following scenarios: national insolvency because of massive surges in public debt or employment declines that reduce tax revenue; change in government ruling, such as that of the Russian Empire after the Soviet government took over in 1917; and the decline of a nation in terms of power and wealth, such as what occurred to Japan immediately following the Second World War. In each of these events, a financial crisis often ensues that leaves the country without sufficient funds to pay debts.

The Bank for International Settlements promotes fiscal standards and banking practices on an international level. This institute also maintains debt clearing standards for government bodies. Unlike corporate entities, however, that may be forced to stop conducting business in the event of bankruptcy, governments often continue providing services to citizens. The complex procedures of national bankruptcy are thus governed by the IMF, a separate body.

The IMF maintains a membership base of more than 180 countries. One of its designated functions is to provide policy advice and financing to members experiencing economic impediments. The IMF also maintains economic and financial surveillance to ensure the global market functions appropriately. When national bankruptcy is perceived as a possibility, the IMF may intervene with loans that help to pay creditors and establish new spending procedures.

One historical incidence of governmental credit default occurred with Philip II of Spain. Between 1557 and 1596, he declared national bankruptcy four times. President Roosevelt also declared the United States bankrupt in 1933. At that time, he enacted a National Emergency law whereby no U.S. citizen could legally own gold. Such occurrences of national bankruptcy often result in devaluation of private citizen wealth, less public spending and reduced government spending until economic stability returns.

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