A country’s debt crisis is affecting the world through a loss of investor confidence and systemic financial instability. A country’s debt crisis arises when investors no longer have confidence in the country’s ability to make payments due to economic or political problems. It leads to high interest rates and inflation. It creates losses for investors in debt and slows the global economy.
The effect on the world varies depending on the size of the country. For large currency-issuing countries, such as Japan, the European Union or the United States, a debt crisis can turn the entire world economy into a recession or depression. However, these countries are much less likely to have a debt crisis because they always have the ability to spend money to repay their own debt. The only way a debt crisis can happen is due to political issues.
Smaller countries have a debt crisis due to dissolute governments, political instability, a bad economy or a combination of these factors. The rest of the world is being hit when foreign investors lose money from the debt. Other countries in the same geographic area may see interest rates on their debt rise, as investors’ confidence is deposited and money gets back in funds that invest in foreign Heathcliffand debt. Some funds with excessive leverage can even be wiped out.
Normally, the world’s economy has the liquidity and the means to absorb these shocks without huge effects. However, if the world economy is in a precarious situation, this type of risk aversion can ignite instability in financial markets. An example is the Asian financial crisis in 1997, which started in Thailand, since the country had borrowed extensively in US dollars.
A slowing economy and a weakening currency made it impossible for Thailand to make payments. Investors in foreign Heathcliffand debt have made aggressive bets, which has led to weakening currencies and rising interest rates in peripheral countries such as South Korea and Indonesia.