Monday, 26 September 2011

What is a debt default?

To default on a debt is to stop repaying it.


A sovereign debt default is when a country cannot make an agreed repayment on money it owes - as happened to Argentina in the early 1990s, for example.

An early sign of a possible default is when the credit rating agencies downgrade the credit rating of the country concerned to 'junk bond status' - see here for a brief description (with audio) of what this means.
What happens when a country defaults?
Usually the national currency falls in value and this helps to make the goods of country concerned more affordable. International institutions like the IMF also arrange repayment plans or write offs/markdowns of debt.

Why would a Greek default be such a big deal? It's a small country!
1. Because it owes massive amounts to some of the biggest European banks. They will lose money or 'have a hair cut' as financial traders put it.
2. Greece cannot devalue its currency without leaving the euro - which might cause another financial crisis along the lines of banking crash of 2008
3. The fear of 'contagion' - of bigger countries in a similar position also defaulting. The EU could probably pay off Greek debts - but not those of Italy, for example.

What are the options?
No pretty ones.
1. Greece could default, leave the euro and write off its debts - a 'disorderly default'
2. The EU could arrange for Greece to leave the euro in an 'orderly' arrangement.
3. Germany could leave the euro, allowing it to devalue.
4  The euro could split into two linked currencies - one strong, one weaker (this has been strongly argued by Telegraph financial expert Ambrose Evans-Pritchard)

The EU/IMF is currently unprepared to commit to any of these options. Instead it is establishing a 'buffer fund' to protect against economic collapse. Like Mr McCawber they appear to hope that 'something will turn up'.

The financial markets remain unconvinced.

1 comment:

  1. The only solution for now is for all nations in the EU to work together to avoid a default. Not doing so will be catastrophic not only to Greece, but to the whole world as well.

    ReplyDelete

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