Sovereign Debt

Debt: the IOUs of the world.

Sovereign debt is only a part of a nation’s debt. It takes the form of bonds issued by a nation in foreign currencies, sold to foreign investors. It’s a government’s IOUs to foreign investors and countries. Sovereign debt is sometimes conflated with the total national debt, which includes the internal debt of a nation.

Usually, bonds are considered a risk-free investment. That’s because governments can pay you back by raising taxes or printing more cash. But bonds from other nations in not-their-currency...are different. Since sovereign debt isn’t in that country’s currency, it can’t just print more of that currency to pay you back. Exchange rates change, economies can take a turn for the worst. This makes sovereign debt riskier than if you bought bonds from your own country in their currency.

Remember the European sovereign debt crisis? That’s when a bunch of European banks fell apart like a house of cards, which made bond yields jump sky-high. Before the European sovereign debt crisis, economic times were good, so public spending was high...and comfortable. It all came crashing down, as many things did at that time, due to the Great Recession. As banks went under and governments came to their aide, this only put the government in even more debt.

Governments with high debt rightfully get the side-eye from investors, since they're at a higher risk of sovereign default. As the risk of having sovereign debt went up, lenders demanded higher interest rates. Before the European sovereign debt crisis, everyone was more confident in sovereign debt as a good thing. But now, people are skeptical. Pinkie promises on IOUs just don’t cut it anymore.

The crisis was quelled as Europe banded together, working with the IMF to downgrade Eurozone debts and build up confidence. Countries receiving handouts had to meet austerity requirements to rein in government spending. Like we said, sovereign debt isn't the safe haven it once was.