The Debt Ceiling: What Is Happening and What Could Happen if the Ceiling Isn't Raised?

Sometimes it is wise for a person to declare bankruptcy but the same is almost never true for a nation. When debts are overwhelming and bills unpayable, an individual or a company can seek the mercy of the courts and obtain protection from aggressive creditors. In the case of Argentina, which declared a moratorium on its debt repayments in December 2001 and within days defaulted on $93 billion (£59.6 billion) in sovereign borrowings, it was the beginning of a nightmare.

There is no bankruptcy court for nations. Defaulting sovereigns pay the ultimate price; they are sent to Coventry, shunned by commercial banks until, somehow, they can purge their debt. The only recourse is to the International Monetary Fund, which can provide emergency loans. Currently, the IMF has a pot of money, some $200 billion from contributing states, which is almost certainly inadequate to the scale of the potential demand that might emerge in the months to come. Iceland has already secured $2 billion, Ukraine has been promised upwards of $16 billion and Hungary is expecting double-digit billions. We have commitments for about 15 per cent of the kitty and the dominoes are tumbling.

For Argentina, the months that followed its "bankruptcy" were horrendous. The country went into a brutal downward spiral of inflation, currency collapse and the rationing of cash by the banks. In a nation that is a big agricultural exporter, children went hungry and and the economy imploded, shrinking by 13 per cent in a year. Unable to borrow to pay its bills, the state was forced to cut public sector wages, slash the state pension and unemployment soared to 20 per cent. Unable to pay for goods with cash, many Argentinians resorted to barter.

A sovereign default forces a nation into self-reliance mode and, if the Government lacks the will to reform its economy, it will tempted to print money to pay wages and pensions. When the choice is between paying Citigroup and paying pensioners, the political choice is obvious. However, it is no solution as the result is hyperinflation and more chaos.

The default on Argentina's commercial loans was bad enough but what followed a year later was the default on an $800 million loan from the World Bank, which left it precluded from further help by international agencies. It became embroiled in lengthy negotations with the IMF and debtors clubs. The country had borrowed too much in foreign currencies and it made matters worse for itself by pegging the value of its currency to the dollar. Argentina became uncompetitive and slipped into recession. When the currency peg was finally severed, the peso collapsed and the country was unable to repay its debts.

IMF loans come with tough medicine and it is this that makes the institution unpopular and its intervention greatly feared. Ukraine is now debating the passage of a law that is a precondition to the IMF bailout and, from what is reported, the country will be forced into an austere regime of budget cuts, tax increases and measures designed to get Ukraine's inflation under control. Iceland has just raised interest rates by 6 per cent — a harsh monetary tightening aimed at shoring up its currency but which will bring further misery to its people.