Wednesday, July 13, 2011

How Bad Would Default Be, Really?

The matter of the debt ceiling crisis has left everybody in America scrambling to try and figure out what, exactly, is going to happen. After all, the United States has never defaulted on a debt.

I'm not going to claim I've got an answer either. But I will say that if there are no suitable analogs in the United States, that doesn't mean we have to run around in general chaos going We Have No Idea. In case anyone's forgotten, there are other countries in the world. And the rest of the world has had money problems too.

So what I'm going to do today is provide a sampling of foreign analogs to the American situation.

*The most commonly-referred to situation, when someone does go foreign, is Greece. Their debt per capita is similar, it's recent, it spawns from the same basic global meltdown, they're also tossing around the word 'austerity'. However, the one thing to keep in mind is the manner in which their austerity is being conducted. Namely, the Greek legislature literally has no choice in the matter. They've taken bailout money from the International Monetary Fund. The EU is more or less dictating to Greece what their remedy will be, on pain of possibly being kicked out of the Eurozone, as there has been discussion of doing. The United States has China as its major creditor, and buys a lot of treasury bonds, but a majority of American debt is internal- Medicare, Social Security, etc. Greece has a formal, explicit obligation to follow the rest of the Eurozone's instructions. Surrender of a degree of sovereignty is a condition of membership. The United States, being so fiercely independent, cannot relate. A bailout of the United States would almost certainly come from the IMF, but as that would entail the IMF imposing solutions of its own, taking a degree of control out of the hands of America, such a bailout seems unlikely, even if the IMF and United States have had historically cozy relations.

*There is a second European nation to considering the same Euro crisis, and that's Belgium. Their main characteristic is their partisanship. As the United States has Democrats and Republicans, the Belgians have ethnic Walloons in the south and Flemish in the north to serve a similar purpose. Flanders has a larger population, but the Belgian legislature is split nearly down the middle. Belgium has a multiparty parliamentary system, which if you're one of those people that wants to bust up the Dems and GOP and go to a multiparty system seems just fine. Belgium, however, shows the downside of a parliamentary system. No matter how you slice the population up, once the elections are over, some combination of people has to form a majority in order for the legislature to function and laws debated and passed.

Belgium has gone for over a year now without finding that majority, a world record. As such, the Belgian interim government is crippled and near-powerless to stop the crisis from reaching them unless they find a majority somewhere in their ranks; elections would leave the country completely government-less at a really bad time. And given that they aren't even speaking to each other, that appears an unlikely ask.

Some Flemish are talking of independence, or at least increased autonomy.

It sounds a fair bit like our situation, only turned up to 11. The problem with using this as an analog, though, is that we don't know how their story ends. The whole point here is to figure out what to do in our situation, and to do that, we need to know how the story ended for others in similar situations. We don't know if they get swept up in the Euro crisis, find common ground at the eleventh hour, or what.

So we have to keep looking.

*The largest pre-recession sovereign default was of Argentina in 1999. Their recession lasted until 2002, and while their economy is now growing more stable by the year, some would say they're still trying to get out from under the fallout. The reason for that is that, upon their default, all of their creditors scrambled to be repaid immediately, and first. Likewise, nobody was about to lend them a dollar more.

The tricky thing about Argentina, though, is in how they valued their currency, the peso. While the dollar is used around the world as a reserve currency- a currency everyone else holds in reserve and measures their own currency against- Argentina, pre-default, tied the peso directly to the dollar. Whatever the dollar was worth, Argentina made the peso worth an equal amount. Once the default hit, Argentina floated the peso- that is, stopped tying it to the dollar. The peso's value promptly went down the toilet.

As a side effect, Argentinian TV stations had to rely heavily on reality shows in order to get by, and cancel the more expensive educational programming.

Argentina would have had to gut their budget, just absolutely gut it, in order to pay the money they owed to everybody. What they ultimately did, though, was stand firm for four years- four years where they were shut out of the international financial market- until they got their creditors to agree to a debt restructuring plan where most of their debt payments were reduced and stretched out until 2006, when an uptick in the economy left Argentina more able to pay debts in full. They have come steadily out of their hole since then; the gap between rich and poor has shrunk. About a quarter of the debt's representatives held out, though. As of 2010, 7.4% of the debt remains unrestructured.

The trouble here is in pre-existing standing: while Argentina was shut out of the financial market, the United States to a large degree IS the financial market. The world could go on without
Argentina's participation, but the United States has too many fingers of too large a size in too many pies to just leave alone like that. Argentina itself had, again, directly tied the peso to the American dollar. America is not currently tying the dollar to the Argentine peso, or any other currency. The dollar is in fact a reserve currency- a currency everyone else holds in reserve, just in case something were to happen with their own.

So three analogs, all with a nagging problem that keeps any of them from being 100% perfect. However, all three, along with other defaults we didn't get into such as Russia in 1998 (PDF), Mexico in 1994, Latin America's "La Decada Perdida"- lost decade- in the 1980's, and anything beyond those listed on the timelines here, have a common thread: pain. Lots and lots of pain. Even getting into the situation in the first place causes pain. Anyone that tells you that an American default would not be painful, one way or another, is stupid and/or lying.

The question is simply, how much pain. Are you hitting your hand with a mallet, putting it on a stove, or shoving it into a wood chipper?

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