Sri Lanka defaulted on its foreign debt and an economic crisis hits Sri Lanka.
Pakistan defaulted on its foreign debt and an economic crisis hits Pakistan.
Reports say that Russian might also default on its foreign debt which is basically due to the fact that the majority of Russia’s FOREX reserves are frozen by the US or EU.
And there are many other examples of such defaults in past: Argentina, Ecuador, Lebanon, Zambia, Venezuela, etc.
All these foreign debts are denominated in dollars. And these debt defaults are Hard defaults.
Hard default means if you don’t have money to pay the debt then you simply refuse to pay it.
But the biggest defaulter among all the countries is The USA.
Wait, what?
The USA is the largest economy in the world. How can US default?
Nobody talks about it and no news covers it, hence nobody knows about it.
The US had defaulted several times in the past, but nobody notice it because it does not do a hard default like the above-mentioned countries did.
How USA default is known as a soft default.
Soft default means if a country does not have money to repay its debt then it simply prints more money and repays the previous debt.
The US did this soft default in 1971(removing the dollar from being backed by gold), 2008(during the great recession), 2019–20(during the COVID-19 pandemic), and will continue to do it.
A soft default is much easier and more convenient than a hard default.
But every time a soft default is done the debt bubble grows big and inflation rises. Hence soft default may be okay in short term but have serious implications in long term.
So why other countries do not do a soft default?
It is because all foreign debt is dollar-denominated. And the only US has the power to print more dollars.
And if these countries try to print their own currency then their currency will depreciate heavily. The inflation will skyrocket. The currency will eventually collapse and be worth zero. This is what happened with Zimbabwe in 2008. When the country printed reckless money and the Zimbabwean dollar crashed along with the Zimbabwean.
So there is no escape for these countries to delay an economic crisis if the debt burden crosses the payment capacity of that country.
Sri Lanka’s debt to GDP ratio is 119% and its economy has collapsed.
Well, guess what’s the debt to GDP ratio of the US…
it is 133% and still, the economy is afloat.
It is only because the US will never do a hard default because it has the option to soft default every time.
But soft default will only work until the entire world is trading majorly in dollars.
The USA is like the dealer at a casino table and the players on the table are from different countries. The table is the dollar table. Well in this game some players will win and some will lose but the dealer always wins.
But what if the players switch to a different table(yuan or bitcoin). Still, some will win and some will lose but the previous dealer will go bust.
Now in no way, I am saying that other countries have gone bankrupt only because of the USA. I only mean if other countries make mistakes their economy collapses but if the USA does it, then it changes the rules of the game. The problem will be when other countries start playing a different game in which rules are not dedicated by the USA.
This is the exact reason why many countries around the world have started to trade in their native currency or a currency other than the dollar. A few examples are:
- Saudi Arabia considers accepting yuan instead of Dollars for Chinese oil sales.
- India is considering taking up a Russian offer to buy its crude oil and other commodities at discounted prices with payment via a rupee-rouble transaction
- India also has a rupee-based payment mechanism with Iran. This essentially means Iranian oil can be purchased with Indian rupees.
For many years dollar maintained its dominant currency status due to oil. After the US removed gold backing from the dollar back in 1971 the dollar had in a way been backed by oil. Or as it is popularly said it is the Petrodollar.
Now, the petrodollar is also getting threatened. The above examples clearly show it.
Also if other countries still use the dollar there is no guarantee that their dollar reserves will be safe. Why?
Because the recent sanctions put on Russia essentially are not allowing Russians to withdraw their money held with foreign institutions. So, how do we know that it might not happen with other countries when they are standing at the opposite end of the US.
Hence slowly, the world is losing faith in the dollar and is finding alternative ways to conduct trade. The casino players are looking for a different table.
So, Sooner or later this soft default hit the US economy much much harder.
As Ray Dalio said, it’s the changing world order.
