A lot of attention in Europe during the economic crisis has focused on the bailouts given to Greece, Ireland and Portugal, as well as the debt deal offerings to Spain. With those bailouts, many within those countries viewed the terms requiring access to funds to be so severe a debt default would be in the greater interest for the state.
Greece has already negotiated a structural default on a portion of its debt, while Ireland appears in line for some sort of debt restructuring in 2013, but let’s look at what a unilateral default would potentially mean, using the case example of the Argentine debt default of 2001.
Argentina is the second biggest economy in South America, the largest Spanish-speaking country by area in the world and home to 44 million people. In 2001, it became the most high-profile country in history to default on its debt.
Argentine debts began racking up during the military dictatorship of 1976-83, which also coincided with the failed invasion of Las Malvinas (the Falklands Islands), another burden on the finances. Late in the 1980s and unable to service its debt, the Argentine saw hyperinflation, with an estimated peak of 12000% in the year 1989.
Another bout of hyperinflation occurred in 1991 and with Argentinians losing all confidence in their own currency, they started demanded payment in dollars. The currency, peso, was pegged to the US dollar in 1991, which brought stability and a reduction in inflation.
This proved unsustainable however as the public debt kept growing which was serviced by loans from the IMF. By 1999, with critically high unemployment and economic problems due to over-borrowing, as well as a reevaluation of the US dollar and Brazilian real, the country went into freefall.
The IMF, seeing the situation deteriorate, responded in much the same way it has to the Eurozone crisis, by demanding austerity. The deficit was at 2.5% in 1999 with external debt to GDP at above 50% (To place the Eurozone crisis into context, pre-bailout Ireland had a 13.1% deficit and debt levels of 108%, while Greece reached a deficit of 14% with 181% debt levels).
With rising bond yields and Argentina consistently failing to meet GDP growth projections – which, incidentally, were predicted by the IMF – more and more was borrowed at below-market interest rates from the IMF, World Bank and US Treasury, who demanded more austerity in return for the loans.
With unemployment of 20%, seven rounds of austerity, a law freezing Argentine bank accounts so money could not be moved out of the country and serious rioting, the IMF refused a tranche of US$1.3 billion until further austerity measures were enacted. The then President, soon after calling a state of emergency, abdicated and the new Rodriguez Saá Government defaulted on a large part of their total borrowing of US$132 billion.
The currency was no longer pegged to the dollar, which depreciated the peso by 70%. This returned the country to competitiveness, which was important for economic growth in future years, but all but obliterated any life-savings its citizens may have had.
This is directly similar to the case of Eurozone countries as they are pegged to the Euro. Any exit from that currency, which would be enforced in the event of unilateral default, would mean about a 50% depreciation in an Irish currency and 65% decrease in the Greek drachma.
During the years following the default, Argentina had massive growth rates of between 8% and 10% in the years up to the current worldwide economic crisis of 2008. Wages also increased annually by 17% during the same period, although a large chunk of this was eaten up by inflation. The argument is that Argentina was able to return its economy to pre-GDP size within three of the crisis while it would be something akin to a miracle if Greece returned to pre crisis GDP before the current decade is out. Therefore, if Greece defaults, then it will recover more quickly.
The Irish economy, meanwhile, is reliant on foreign national corporations – many of whom including Microsoft, Google and Hewlett Packard have their European bases in Ireland – which set up in Ireland in order to avail of low Corporation Tax rates. A unilateral default would likely mean expulsion from the euro for Ireland and would thus become less attractive to these companies as it would no longer operate within the biggest currency in the continent and a large degree of trust in the country’s financial system would be lost.
Perhaps the most important factor though is to consider how far Argentina sunk during the years after the default – poverty rates above 55% with 25% unable to feed themselves sufficiently – these figures are astonishly high, in comparison to troubled Greece’s poverty rate, which is currently at 22%; Ireland’s is at 16%.
With Ireland having one of the highest levels of personal indebtedness in the world, poverty would increase massively as more and more citizens would simply be unable to pay back debts, because the cost of living would increase massively as inflation would rise to offset the depreciation in the currency. As in the case of Argentina even to this day, any goods necessary to be imported into Ireland would rise dramatically in price.
A default also doesn’t mean debt doesn’t have to be repaid. IMF money lent to countries is considered “privileged” meaning it must be paid back above all other debts. Argentina paid over US$10 billion back to the IMF between 2005 and 2008, while most other debts were restructured at 20-30% of their value repayable over a longer time frame. Many organisations, like ‘Taskforce Argentina’ have mobilised individual creditors to force repayment from the Argentine Government.
Currently almost 93% of Argentine debt from the default has been restructured, while it remains under threat of litigation from the remaining 7%. 11 years after defaulting, Argentina remains unable to borrow on international markets, while continuing instability with its currency sees the peso consistently rising against the dollar and inflation levels believed to be above 20%. Officially, the Argentine Government claims the inflation level is around 10%, but most analysts claim this is a manipulation of the figures.
So what awaits a Eurozone country willing to default? Probably a return to strong growth within two years, but a massive increase in poverty levels following the default, a depreciation of the new currency, an exponential rise in inflation, a disappearance of savings, a fall in income and an increase in the cost of any imported goods for citizens.
The current situation within the eurozone, or even within the wider European Union, may not be perfect with a clear lack of democratic accountability and the major nations continuing to rule in their own favour over the interests of the indebted, peripheral state, but still, as the saying goes, it’s better the devil you know.