1. Types of default

In view of the complexity of default, we should first clarify its concept and which category we are discussing. Ruth has introduced four types of defaults, namely debt rescheduling, debt restructuring, suspension of debt repayment, and refusal to pay debts. The accurate meaning is as follows.

Debt rescheduling. The debtor and the creditor negotiate and reach an agreement to postpone the payment of outstanding debts by extending the expiration date of the existing contract, interest payment or installment plan, so that the principal can be repaid in full in the future. The creditors agree that the debt rescheduling is mainly to deal with the transitional period of insufficient liquidity and does not involve any reduction in the face value of the debt.

Debt restructuring. The debtor and the creditor negotiate and reach an agreement to cancel part of the outstanding debt through write-down or forgiveness, in order to be able to repay the remaining debt in full in the future. The main purpose of restructuring is to deal with bankruptcy in an orderly manner, which can be achieved by reducing the face value or lowering the contractual interest rate. Debt restructuring is also called discount, write-down, debt relief, and orderly default.

Suspension of debt repayment. The debtor unilaterally suspends the payment of the interest and principal stipulated in the contract in order to be able to resume debt repayment in the future. The suspension of debt repayment involves the debtor’s attempts to weather a period of insufficient liquidity and financial difficulties. It does not formally deny the debt, nor does it involve a reduction in the face value of the debt.

Refusal to pay debts. The debtor unilaterally refuses to admit the binding nature of the debt, in order to never repay the debt. Therefore, the refusal to repay the debt involves a public statement issued by authorized officials in which the government explicitly refuses to perform the debt contract, regardless of whether the debtor has the ability, or whether the creditor accepts the fact that the debtor refuses to repay the debt.

Unilateral default means that the debtor’s interest takes precedence over the creditor’s interest. The debtor deliberately transfers the adjustment cost to the creditor. Since debt rescheduling and debt restructuring are generally beneficial to the creditor, the book focuses on two types of unilateral defaults: suspension of debt repayment and refusal to repay debt.

2. Traditional theories on debt repayment

Why do debtor nations still insist on repaying their debts under very difficult conditions? This eye-catching core mystery of international lending has long been known as the "Implementation Problem" of cross-border debt contracts. In relevant discussions, there are probably four explanations: the debtor's long-term reputation, law and sanctions, democratic system and spillover costs.

Reputation hypothesis.Some studies believe that debtors avoid default in order to maintain their good reputation, so as to make them easier to enter the international lending market in the future with a lower cost. There are two key inferences for reputation hypothesis: One is that creditors can refuse to provide more credit rationally and integrally after the occurrence of default; Second is that creditors treat debtors differently according to historical repayment records and require debtors with default records to pay higher risk premium. However, when analyzing default cases, the evidence seems not to support the above two inferences.

For the first inference, if investors have long-term memory, then Argentina will not become the favourite and spokesman of investors, as a continuous defaulter in the international lending market. However, the fact is that Argentina continues to win the favor of creditors. Creditors seem to focus only on recent gains rather than the reputation of default a long time ago.

For the second inference, the research on emerging market debt in the 1990s verified again that the risk premium faced by former defaulters was not higher than those debtors without default record. Generally speaking, the impact of default on the risk premium was short, usually ranging from several months to around two years. Therefore, the reputation hypothesis seems not able to explain effectively why debtors insist on repaying their debts in the current.

Law and sanctions hypothesis.Theopinion oflawhypothesis is:Because the debtors' international debt is usually valuedin foreign currency and is governed by other laws. Thereforethe debtor is subject to the law of the country where the debt is issued, and the debtor may not be able to protect himself from the aggressive litigation conducted by the creditor in the issuing country. However, the facts do not support this hypothesisas well. Within three years of Argentina's default in 2001, about 140 lawsuits were filed against Argentina in several jurisdictions. Although creditors won most of the lawsuits, it was futile to claimfor compensation ofArgentina's foreign assets in the next decade. Some studies have found that litigation has no significant impact on bond yields, relying on legal sanctions alone seems not feasibleto establish a credible enforcement mechanism.

Some other literature regard direct punishment as the enforcement mechanism of the debtors' performance. The punishment can take two forms: Detaining the debtors' assets abroad; Impose a trade embargo. Other studies have emphasized the importance of so-called super sanctions, in which external financial control, military coercion and the threat of direct occupation are the main forms. Thecommonpoints of these sanctions arethat they attempt to raise the cost of default to a levelthrough somecertainform of direct action by creditor,which issufficient for debtors to consider it fitstheir own interests to repay foreign debts. It is same asreputation hypothesis, sanctions hypothesis is still confined to the category of cost-benefit analysis of neoclassicism. However, the practical evidence does not support the sanctions hypothesis. In the 1980s, when Argentina and Peru unilaterally defaulted on foreign creditors for a short time, the U.S. government never imposed or threatened to impose sanctions on these two countries. In the case of Argentina's default in 2001, the United States never imposed any sanctions on italso.

Democratic hypothesis.The opinion of democratic hypothesis is: Afree parliament, an independent judiciary, a powerfullegal system and the system ofcentral bank whichensurea stable currency significantly enhance the control of wealth holders over the government, so as to limit administrative power and reduce the possibility of default. One problem ofthis hypothesis is that its logic is tenable only when creditors are domestic voters. For some developing countries, they rely more on foreign debt, their domestic democratic institutions do not represent the interests of foreign creditors, and foreign creditors cannot alwaysclaimlegal or political complaints to the courts or parliaments of the debtor governments. More importantly, the evidence does not support the democratic hypothesis. Information about institutional reform barely has a rapid and significant impact on bond yields, this indicatesthat investors usually do not know or are not interested in the institutional characteristics of their potential debtors.

Spillover cost hypothesis.Theopinion of thishypothesis:Default will causespillover costs to the domestic economy, such as the domestic financial systemmay possible collapse, the riskof stock market will rise, private sectors get less access tocredit, foreign direct investmentwillescape, trade creditis not possible to obtain and so on. However, the spillover cost of default is generally short-termand usually disappears after one or two years. Default is unfavorable to the domestic financial sectorsand the export sectors whichrely on trade credit, but due tocurrency devaluation, it is beneficial forthe domestic industrial sector to competewith imported goods, because imported goods are more expensive. Therefore, on the whole, the spillover cost may not be so large, and the spillover costonlycannot explain the debt repaymentmysteryalso.

3. Three mechanisms promotingdebt repayment and modificationsofinternational financial structure

So,what are the reasonsthat incentive debtors to repay their debts? Ruthproposed three mechanisms thatpromote the debtors’performanceand the modifications ofinternational financial structure behind. The three mechanisms are:

First, international creditor Cartel imposes amarket rule thatrefusesto provide further credit to non-performing governments. If these debtors rely heavily on credit, suspension of credit will lead tolarge spillover costs;

Second, international official creditorssuch as creditor governments and IMFprovide conditional loans to debtor countries,whichkeep the debtors to besolvent and debtor countriesare able tofree up resources to repay foreign debt. Otherwise,therefusal to provide further of credit official creditors' will lead tolarge spillover costs;

Third, the financial orthodox domestic elites play theroleas bridges, their influence is enhanced because they can attract foreign credit with better conditions.Thishelps to internalize the debt repayment discipline and financial discipline into the state organs of debtor countries.

The reason why the three mechanismsillustratedbefore play an important role in promoting the continuous debt repayment of debtor countries is that the international financial structure has undergoneprofound changes since the disintegration of the Bretton Woods monetary system in the 1970s. These changes have imposed strict limits on debtors. Afterconsideringthe advantages and disadvantages, even if debt repayment will causesevereadverse consequences, the debtor is stillunwilling to choose unilateral default.

The first important modificationis that the international credit market continues to be concentrated, resulting in more and more debtors' liabilities being held by private banks and financial institutions with systemic importance and strong political power in a small range of developed capitalist countries. Large banks and institutions usually have a common interest in promoting debtors' repayment, which means that they are more likely to form a allianceagainst debtors in crisis.The interests of these creditors are twined with each other at the level of a highly integrated global financial system, which makesit easier for them to coordinate the collective renewal of maturedebt andprovidefurthershort-term credit lines to maintain debt solvency and ensure maximum debt repayment.Throughpromoting this unstable balance between sustained financing and the credible threat of withdrawal of creditin large scale, the centralization of international credit markets has greatly enhanced the effectiveness of the first implementation mechanism.

The second important change involves major creditor countries and international financial institutions, effectively incorporating official sector intervention into the global financial architecture. The increasing concentration of the international credit market has caused many financial institutions to be regarded as "too big to fail." The accumulation of foreign government debt on their balance sheets means that disorderly defaults by debtor countries may trigger financial crises in creditor countries. Therefore, from the perspective of global financial stability and creditor countries, an international official creditor is needed to rescue troubled debtors to prevent the crisis from spreading to banks and institutional investors with excessive exposure to core countries. The second mechanism also revolves around simple credit rejections. Taking into account the short-term destructive effects of stopping foreign financing altogether, the threat of official creditors refusing to provide future installment loans is usually sufficient to ensure debtor performance.

The third important change involves the national financial morphology and domestic political and economic reforms of debtor countries in recent decades. It is characterized by the continuous increase in the level of public debt and the government's increasing reliance on private credit. Since the 1980s, under the impetus of neoliberalism, countries have gradually loosened control over financial markets, and the scale of international capital flows has continued to expand. Countries have rushed to create preferential conditions in order to attract foreign loans and investment. This strengthens the political status of social groups whose material interests and ideologies are broadly consistent with those of foreign creditors. The wealthy domestic elites, especially the fiscally orthodox and business-friendly technocrats, usually stimulate the confidence of foreign creditors and make credible commitments. This higher "credibility" means that the government and official financial institutions can generate internal impetus to attract credit with better conditions, so that the debtor's discipline is internalized in the debtor country's institutions, thereby consolidating the role of the third implementation mechanism.

4. Financial structural power

The direct manifestation of the above three mechanisms is financial structural power. The book defines structural power as the ability to refuse to provide others with what he depends on. This ability gives the holder a special power: the power to punish by not doing it, and the power to restrain by refusal. Structural power is that its holder can change the range of choices open to others, rather than directly exerting pressure on them to make a decision or make a choice instead of other choices.

Benjamin Cohen also talked about a similar concept. National power has two dimensions. One dimension is the active influence, and the other is autonomy, that is, the ability to choose what not to do. Ruth is discussing the ability to punish by not doing, while Cohen discusses the freedom to choose not to do because of a certain power. For example, from the perspective of international currencies, the issuance of international currencies has a lot of freedom. Even if the balance of payments continues to maintain a deficit, they have the freedom not to make adjustments, but to impose adjustment costs on other countries.

It is the country's dependence on credit, in fact, the broader economic structural dependence on credit, which ultimately gives finance a unique form of power in a capitalist society: structural power. The three changes in the international financial structure described above have given different subjects special structural powers.

Increasing market concentration means that in the eyes of investors and policymakers, financial institutions at the core of the global financial system are “big to fail”, thus giving these institutions a higher privileged position in economic decision-making. Survivability is now vital to the normal operation of the entire system.

Financial liberalization did not lead to the retreat of nation-states and the rule of free markets. Instead, it highlighted the role of international institutions and international organizations in financial liberalization. Since the 1980s, state actors, central banks, and international organizations have acted as market makers. The role of commerce and the final creditor is becoming more and more important.

The country’s increasing reliance on credit has further eroded the country’s autonomy with respect to finance, and has dramatically reorganized the internal power relations of debtor countries to benefit financial companies, financial elites, and financial officials.

5. Breach the contract when the contract is breached?

Under normal circumstances, the debtor has come close to defaulting, either because of problems in domestic economic development, or because of greater international shocks. In fact, the economic and financial situation may have been struggling. At this time, they will continue to repay their debts. Have a serious negative impact on the country. Generally speaking, the effects of insisting on debt repayment and implementing structural reforms are asymmetrical. Some policies such as fiscal austerity, abolition or reduction of welfare, and tax increases may have a greater impact on low-income groups, but have less impact on high-income groups. It may even produce results that are beneficial to high-income groups. No matter which country it is, after insisting on repaying debts and implementing structural reforms, the domestic economy has experienced a sharp decline and the unemployment rate has risen significantly. Take Greece as an example. After accepting the harsh conditions of the bailout, the Greek economy took a sharp turn and almost lost 1/3 of its GDP. The unemployment rate once reached 25%. Greece experienced one of the most severe contractions of the developed capitalist economy in peacetime.

In addition, insisting on repaying debts may have political consequences. Take Greece as an example. With the deepening of the debt crisis, in order to repay debts and implement austerity reforms, the Greek government often resorts to emergency decrees and administrative orders to bypass the parliament to eliminate widespread social and political opposition to further austerity and neoliberal reform. Ironically, the recognized birthplace of democracy has become less democratic because of debt repayment.

On the contrary, creditors have made a lot of money because of continued debt repayment. As far as international debt crisis management is concerned, moral considerations and economic rationality are ultimately far less important than financial power and the narrow egoism of the dominant creditor countries and international financial institutions. Historical experience shows that the negative impact of unilateral defaults generally lasts from 6 months to two years. Since investors’ memory is short-lived, long-term exclusion from the international capital market is not a worrying issue.