(2010-07-19) Sovereign Debt Default Scenario

A Calculated Risk anonymous reader provides a Really Bad Scenario of Sovereign Debt default. In the Really Bad scenario, 45% of the countries with large outstanding sovereign debts are in default within a 2-3 year period. As we saw in Part 2B, levels between 40% and 50% of sovereigns in default have been reached five times in the last two centuries, (1830s, 1840s, 1880s, 1930s, 1940s). So, who defaults? A simple method is to choose the 45% of countries with large sovereign debts (over $50 billion) that currently have the highest cumulative probability of default... But then, since this is a really bad scenario, Japan defaults too. This might occur because of a global economic slowdown, a rise in general risk premiums and interest rates raising Japan’s debt service (this could take longer, Japan’s average maturity is 5-6 years), Japan’s banking system being affected by defaults elsewhere in the world, lack of political will to make reforms, or several other mechanisms.