How to Default on Sovereign Debt

In December 2001, the Government declared default on its external debt.

The default is on.

Credit Default Swaps on Trial

The fact is that Greece had no right to borrow from German or any other European taxpayers at a time when its public debt was unsustainable. Before Greece took any loans, it should have initiated debt restructuring and undergone a partial default on debt owed to its private sector creditors.

True, the country s periodic debt crises are often the result of self destructive macroeconomic policies. But, this time, the default has been triggered by a significant shift in the international sovereign debt regime.

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Lately, concerns about America s unsustainable fiscal deficits have, likewise, resulted in ugly political infighting, almost leading to a government shutdown. A similar battle is now brewing about America s debt ceiling, which, if unresolved, introduces the risk of a technical default on US public debt.

LONDON Everyone knows that Greece will default on its external debt. The only question concerns the best way to arrange it so that no one really understands that Greece is actually defaulting.

If you deliberately aim to shrink your GDP, your debt to GDP ratio is bound to grow. The only way to cut your debt (other than by default) is to get your economy to grow.

NEW YORK The Greek euro tragedy is reaching its final act it is clear that either this year or next, Greece is highly likely to default on its debt and exit the eurozone.

In countries that borrow in their own currency and can monetize the public debt, a sovereign debt crisis is unlikely, but monetization of fiscal deficits can eventually lead to high inflation. And inflation is like default a capital levy on holders of public debt, as it reduces the real value of nominal liabilities at fixed interest rates.

Unlike in 2013, the strategy of Ryan and his allies this time around is unlikely to include a threat to default directly on federal government debt. And Republicans on the committee claim that social security payments will be made on time.

This approach has several advantages by leaving the face value of the debt unaltered, EU officials could argue that restructuring Greece s debt did not amount to a default, thereby limiting contagion. European banks holding Greek government debt could keep pretending that it is worth its full value.

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For impunity be default read impunity by default

Indeed, lenders are supposed to be experts on risk management and assessment, and in that sense, the onus should be on them. The risk of default or debt restructuring induces creditors to be more careful in their lending decisions.

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Moreover, many banks had so much public debt on their balance sheets that they would have been bankrupted in the event of a full blown default. This led to extreme instability in the eurozone s banking system.

In the eurozone, Ireland, Greece, Portugal, and Cyprus all had to restructure their sovereign debt to avoid outright default. Rising debt GDP ratios cast a pall over fiscal policy, and became the main justification for austerity policies that prolonged the slump.

French officials apparently don t recognize the importance of the fact that Britain is outside the eurozone, and therefore has its own currency, which means that there is no risk that Britain will default on its debt. When interest and principal on British government debt come due, the British government can always create additional pounds to meet those obligations.

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On July 6, the People s Bank of China raised its benchmark interest rate for the fifth time since October 2010. This has generated apprehension about property markets, and fear that local governments could default on part of their staggering debt of 1.65 trillion.

A vicious circle of public finance deficits, current account gaps, worsening external debt dynamics, and stagnating growth can then set in. Eventually, this can lead to default on euro zone members public and foreign debt, as well as exit from the monetary union by fragile economies unable to adjust and reform fast enough.

In countries that cannot issue debt in their own currency (traditionally emerging market economies), or that issue debt in their own currency but cannot independently print money (as in the euro zone), unsustainable fiscal deficits often lead to a credit crisis, a sovereign default, or other coercive form of public debt restructuring.

The eurozone sovereign debt crisis appears to have been the worst managed financial crisis since Argentina s default in 2001. The European Union and eurozone leaders have seriously discredited themselves.

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The 1932 default on Britain s WWI loans from America remains the largest blemish on the UK s debt history, but the background is crucial. The world emerged from the Great War in the shadow of a mountain of debt that the victorious Allies owed to one another (the US being the only net creditor), and by the losers to the victors.

Banks and other financial institutions had doubts about the value of various asset backed securities on their own balance sheets and on those of potential counterparties. No one knew the real value of credit default swaps and of the various tranches of collateralized debt obligations.

Today, the leading edge of that dénouement is the impending decision on the next round of Greek aid, which threatens to break the mold on the scale of official debt forgiveness, defy the IMF s presumed insulation from default, and fundamentally alter the eurozone s legal framework.

Adherence to the principle of non default produced the French Revolution, the lesson being that political systems will collapse if they take on too much debt and try to pay at any cost. The situation was the reverse of Britain.

Repay some debt It sounds counterintuitive, but countries in default should consider paying some of their debts on their own terms and on a graduated basis as a way to rebuild creditworthiness. If the explanation for a default includes an assertion that payments should be tied to economic recovery, then it can make sense to specify the conditions for resuming payments and follow through when the conditions are met.

Second, if the holdouts are paid in full, the majority of creditors who accepted a haircut can request to be paid in full, too. If that happens, the country s debt burden will surge again, become unsustainable, and force the government in this case Argentina, which is servicing most of its debt to default again on all creditors.

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