What do we really mean by default?

By THIS IS MONEY
Updated:

 

After a week when we have been through another political charade around the sovereign debt issues, there at last seems to be a realisation that something is going to have to give.

The term default is obviously unacceptable to the authorities, but it of course can take many forms.

Actual default implies an aggressive 'can't pay, won't pay' attitude. The reality will be an adjustment and rescheduling of the debt over an extended period of time. However, defaults come in other colours as well.

These could include devaluation of the currency and of course the erosion to the value of the debt via inflation.

On that basis you could argue that by devaluing the dollar so much, the US has already in effect defaulted on its creditors.

Equally the UK is achieving the same; with real inflation around 5% we are eroding around £24bn of debt each year.

No one would suggest that such actions are a deliberate policy of default on our obligations, but it underlines that this is not such a black and white, right and wrong subject.

The key issue is that the problem of the debt lies not with the nations themselves, but with those that hold the debt – and that of course is the banks.

This means the ECB has to play a careful game of stringing out the story, so that those banks most deeply affected by any such rescheduling have sufficient time to take the necessary action of shoring up their balance sheets.

So when is this restructuring likely to occur? The key may be at the next round of German elections, and once they are out of the way and assuming that Mrs Merkel has retained power, then surgery could commence.

However, the UK must not be too smug and merely see this as a Euro zone issue.

The UK is also on the hook with its banks holding such paper; especially the like of RBS - its Ulster Bank subsidiary is deeply mired in Irish debt.

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