Will EU copy Argentina by default?

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Shoppers in Buenos Aires, December 2010
Image caption,
Argentina's economy is now booming, nine years after its default

The cloud hanging over European financial markets is the risk that a government might default on its debts and fail to make the payments due to its creditors.

The financial rescues for the Irish Republic and Greece are largely about ensuring they don't default, at least for now.

But would it be such a disaster? After all, there have been government defaults for centuries, some by countries that are now leading developed economies.

In a history of financial crises, Carmen Reinhart and Kenneth Rogoff (economists at Maryland and Harvard Universities) write that Spain defaulted on its foreign debt 13 times in four centuries.

Pre-revolutionary France also did it repeatedly and had a particularly gruesome way of restructuring domestic debt - executing the creditors.

That might just appeal to some people now who think the austerity now being pursued in Europe is unjustified. The most important creditors are, after all, banks.

The most recent example of a major default was Argentina in 2001, which also devalued its currency shortly afterwards.

The Argentine default was a massive one. Eventually in 2005, bondholders were offered new bonds in exchange.

The International Monetary Fund calculates that the offer meant a loss of 75%. Nonetheless, more than three-quarters of the bondholders accepted.

Bust, then boom

For Argentina, the crisis was a traumatic experience. The economy contracted by a total of 15% in the year before and after the default - and the year before an event can be affected if it is widely expected.

Inflation soared, which worsened poverty, according to the IMF. Prices rose by 40% in the year after the default and devaluation.

You certainly can't blame all the problems on the default. The devaluation contributed to the surge in inflation and to the problems in the banks.

The default also curtailed the Argentina's government's access to international financial markets.

But after the initial collapse, the economy bounced back. It grew at average annual rate of 8.5% in the six years from 2003.

Unemployment fell by more than half. Inflation came down after the initial spurt, though it remains high and there are persistent issues about the reliability of Argentina's price data.

Image caption,
Argentina's 2001-02 financial crisis led to street protests

The devaluation was an important part of this story as well, as it made Argentine goods more competitive.

The default helped the government's finances. The burden of government debt as a share of national income declined from nearly 150% in 2002 to less than 75% in 2005.

The short-term effect was especially pronounced, because so much of the payments were pushed into the distant future - up to 42 years in some cases.

Relief for now, but Argentina needs to hope that its government finances will be in good shape when those future bills come due.

Sooner or later...

What about the lessons for Europe? Mario Blejer, who was the governor of Argentina's Central Bank in the aftermath of the default, said in a BBC interview that default was "a little bit like divorce".

"It is not a nice thing to do, but sometimes it is better to have a divorce than continue a situation that is unsustainable, that is more expensive at the end of the day," he added.

And what about the loss of access to international financial markets?

Image caption,
The Irish are feeling the pain of economic austerity

Adam Lerrick is an economist who negotiated on behalf of a large group of European and Japanese private individual investors who had bought Argentine bonds.

He says the big institutional investors that lost money were ready to lend again the day that the debt restructuring was completed.

Both Adam Lerrick and Mario Blejer agree that a default by some countries in Europe will come sooner or later. Mr Lerrick says they cannot repay "without enslaving themselves for decades".

Mr Blejer nonetheless thinks the bail-outs can serve a useful purpose. Banks will lose money if and when a default happens. The bail-outs give them time to prepare by raising extra capital to absorb those losses.

Mr Lerrick says the banks should lose everything they have invested before European taxpayers pay a single euro.

Quoting a colleague, Allan Meltzer, he says: "Capitalism without losses is like religion without sin. It doesn't work."

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