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S ource: BBC

If I borrow £1,000 from you and then, because of spectacular bad luck cannot pay it back, but I come to you and say, “here is £750, can we call it quits?” – that is a controlled default.

If I borrow £1,000 from you and you ring me up and you get directory inquiries in the Dominican Republic – that is an uncontrolled default.

Right now, Greece’s fate hangs in the balance somewhere between these two. It has already received what economists called a “haircut”. That is a voluntary agreement from its creditors to take 79 cents in the euro and extend the loans for up to 30 years. Ninety per cent have signed up to this.

Anything more than that should trigger a “credit event” allowing those who have insured themselves against losses on Greek debt to start calling in their money. That is what politicians fear will shoot the Greek debt issue like a sabot anti-tank round straight through the hull of the global economy.

The best example we have of an uncontrolled default is Argentina in 2001.

Mass protest

Argentina had pegged its currency to the dollar, but an economic downturn forced its budget deficit through the roof and without devaluing it could not compete its way back to fiscal solvency.

Interestingly, the International Monetary Fund (in a document approved by Timothy Geithner) said of April 2001:

“At this stage, serious consideration should already have been given to an involuntary debt restructuring, with reduction in the present value of the debt, accompanied by an exit from the currency board arrangement.”

That is – they should have defaulted and unpegged the currency.

But they did not. The IMF gave them more money and told them to do some more austerity (albeit not on the scale the European Union is demanding of Greece today).

It all fell apart in November 2001. There was a run on bank deposits, the banks closed their doors, there was mass protest in the streets and the president left his palace by helicopter.

Today, Greek protesters hang a banner on the railings of parliament showing a helicopter lifting Prime Minister George Papandreou to safety.

However, there is a difference between Argentina and now, and it is not really the euro – from which there is no possibility of exit according to EU President Herman Van Rompuy last week (it is not a café, he said, you cannot leave).

‘Acute crisis’

The difference is politics. Argentine politics were inherently unstable – the IMF could never be sure who it was dealing with or whether they would stick to agreements.

In Greece you have a highly organised Pasok political elite that has already done one inner-party coup without collapsing. And an opposition party that has shown once that it does not want to take over in conditions of acute crisis.

Both in the shape of Evangelos Venizelos (the party enforcer) and Elena Panaritis (the non-elected, Western-educated MP advising Papandreou) and Mr Papandreou himself they have people with a lot to lose reputationally, and of some considerable competence.

The Pasok leadership’s problem is not that it will not agree to austerity, it is that Greece is becoming ungovernable. However, it has not yet become so and in that breathing space the global authorities, the EU and the Greek political elite do have the space to do some form of controlled default, as the IMF believed Argentina should have done. There will be a bonfire of euro vanities, Mr Van Rumpuy will be cross etc. But that is one option.

An orderly default however, involves the mass transfer of funds from north Europe to Greece. If we are serious about the danger of a Lehman style event – which wiped $32tn off a global stock market worth $65tn – then the entire euro 210bn does not look that big, and it will not cost the whole amount.

To avoid it just being a sticking plaster it would have to come with large amounts of fiscal transfer, as suggested on 21 July, in the form a quasi-Marshall Plan (since eurobonds are off the agenda due to the German court ruling).

However, once Greece goes, there is a danger of three kinds of contagion – to other countries (Ireland, Italy, Portugal, Spain in that order, I think); to the banks (starting with Dexia and the eight Greek and Cypriot banks); and via the CDS market to the US and UK financial system, including the hedge funds – whose bets we do not have the luxury of understanding.

Leave aside any attempt to leave the euro – even to do austerity plus default will be a challenge for the Greek government, and the West should not believe there are a bunch of apolitical technocrats, or competent centre rightists just waiting in the wings.

The Greek political class already looks quite detached from the people – many Greeks joke that Mr Papandreou himself speaks better Swedish than Greek, and is not alone in having swapped Greek “cred” for Anglo-Saxon “cred”.

You would probably see a second attempt to form a national government in the wake of a controlled default, uncontrolled would almost certainly lead to a snap election.

All this is by way of answering the question: what would a default look like? That’s what.

 

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