But when interest rates go up for the wrong reason — because investors don't trust the U. The result is that to some degree, investors seeking shelter would be more cautious about assuming that Treasury securities are the go-to investment to protect the value of their assets.
The logical move would be for them to begin directing at least some of their investments to securities issued by other governments and denominated in different currencies. A side effect of those new capital flows could be a challenge to the dollar as the world's "reserve currency. A reserve currency is money held by a country's central bank and large financial institutions in order to facilitate global trade for domestic companies, to meet international debt obligations, and to influence domestic currency exchange rates, among other reasons.
The stability of the dollar has made it the dominant global reserve currency since the end of World War II. This has generated constant global demand for dollars, making it possible for the U. The United States' global competitors, including China and Russia — but even allies, like the European Union — have for years suggested that it would be better if the dollar's dominance were not as complete as it is.
There has been little movement to unseat the dollar in recent decades, but a shock like a default on U. Search Search. Home United States U. Africa 54 - November 12, VOA Africa Listen live. VOA Newscasts Latest program. VOA Newscasts. Previous Next.
This is when the country cannot repay its debt, which typically takes the form of bonds. So if the US were to default, it would essentially stop paying the money it owed US Treasury bond holders. A quick refresher: the US government spends more money than it collects in taxes. So to make up the shortfall, it raises funds by asking investors to buy US Treasury bonds.
Investors, such as the Chinese government and pension funds, do this because these bonds are seen as a safe place to invest money. No one really knows exactly what would happen, but the likelihood is that markets around the world would plunge and global interest rates would rise. This is because if the US government could not repay the money it owed bondholders, the value of the bonds would decrease.
And the yield - the return the government pays to an investor - would rise. This is because it would be perceived as a less safe investment. This would prompt interest rates around the world, which are often tied to those of US Treasuries, to spike. Furthermore, the impact on the US's creditors could be dire.
Each day, the US Treasury receives a little over two million bills from various federal agencies. Technically, the payment systems can be turned on - to make payments - or off - but not much else. Because of fear of contagion can spread to other economies, countries with close ties — particularly those that own much of the country's debt — will sometimes step in to avert an outright default.
This happened in the mids when the United States helped to bail out Mexican bonds. Whereas some investors look at a financial crisis and see chaos and losses, others recognize a crisis as a potential opportunity.
These investors believe that sovereign default represents a bottoming out point — or something close to it — for government bonds. For the optimistic investor, the only logical direction for these bonds is up. Much like a debt collection agency buys personal credit accounts at a low cost, these funds purchase defaulted government bonds for a fraction of their original worth.
Because of the broader economic fallout that follows a sovereign default, investors frequently seek to pick up undervalued stocks in that country as well. Investing in defaulting countries comes with its fair share of risk, of course, because there is no guarantee that a rebound will ever take place, and the larger issues that caused the default in the first place may still persist or are yet to be fully worked out.
Those seeking security in their portfolio above all else should probably invest elsewhere. However, recent historical examples are encouraging for the growth-oriented investor. For instance, within the past few decades, equity markets in Russia, Brazil, and Mexico increased substantially in the wake of a bond crisis. The key is to look for companies with competitive advantages and a low price-to-earnings ratio that reflects their elevated risk level.
There have been numerous government defaults over the past few decades, particularly by countries that borrow in a foreign currency. Fixed Income Essentials. Corporate Bonds. International Markets. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.
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