Explainer: What’s the Big Deal About Default

Wondering why exactly economists are so freaked out about a possible default? You're in luck. Here's a 100% jargon-free Explainer anyone can understand.

People have credit cards. Countries have bonds.

Credit cards are really useful. Sometimes you need to buy a big-ticket item, a washing machine or a car, and you just don’t have the whole sum up front. Sometimes you’re just a little bit short of cash one month, but you know you’ll be good for it soon. So you borrow. And you pay it back over time. It’s normal. It’s fine. 

 
You don’t even realize how much everything you do depends on credit until you can’t get any.

Countries do the same thing with bonds. When they need a big-ticket item and can’t afford it all at once – a major refinery, say, or a new highway – or when they’re just a bit short, but they know it’s temporary, they print up IOUs, sell them to whomever wants them. If all goes well, they then pay back those IOUs – with interest – when they come due. That’s all a ‘bond’ is, really – a way to borrow. It’s normal. It’s fine.

But sometimes people aren’t careful with their finances, or their circumstances change, or both. Suddenly they have more credit card debt than they can afford to pay back. And when that happens, it’s not fine. Actually, things can get really unpleasant pretty fast.

Fail to pay your Credit Card bills and your credit rating tanks. And once you have Bad Credit, you just can’t borrow anymore. Nobody will lend to you. This makes life really complicated. Unmanageable in some ways.

You don’t even realize how much everything you do depends on credit until you can’t get any. When you go to get a cell phone and you see that alluring “$0 for a Samsung G5 with a two year contract” offer, it’s not immediately obvious that that’s a credit deal: they’re loaning you the money for the phone and you’re paying it in monthly quotas over two years. Bad credit? Forget about that G5.

Bad credit, means living in a Cash Up Front economy.

And that’s not all.

On some loans, you put up collateral. And if you miss your payments, the guy who lent the money to you can pay himself back by calling the Repo Man and just grabbing your collateral. They can do it with your car, sure, but not just that. They can go to a judge and tap right into your bank account.

Scale that up to country level and you start to get a sense of why economists are so freaked out that Venezuela (or its mini-me, PDVSA) might default on its bonds later this year. If you think it’s awkward for one person to get by without being able to borrow – and it is – it’s 30 million times more awkward for a country. If you think access to food and medicine is bad in Venezuela right now, just wait until the country just can’t transact abroad anymore.

 Every interaction between Venezuela and the outside world has a credit component. Without credit, Venezuela is North Korea.

At country scale, there are zillions of analogues to that $0 Cell Phone example. In the world of international commerce, credit is king. It’s everywhere. We’re talking about all the imports, not just the ones you’re thinking of (food, medicine) but also the ones we tend to overlook (spare parts for printing equipment for packages for supermarket products, refinery components, chemicals to treat drinking water, and an enormous, unfeasibly huge etc.)

And imports are more than just things. Want to make a phone call to your friend in Panama? CANTV will have to make a payment to the Panamanian telecoms firm that receives the call, and you can bet there’s a credit component to that contract. Want to fly abroad or watch foreign TV via satellite? Credit is woven right into the service economy in millions of ways you can’t always see.

One way or another, every interaction between Venezuela and the outside world has a credit component. Without credit, Venezuela is North Korea.

And that’s not all. There’s also the Repo Man.

In PDVSA’s case, it won’t be a dashing young Emilio Estevez taking our stuff – it’ll be an army of very ridiculously overpaid New York lawyers.

If PDVSA doesn’t pay its bonds this year, lawsuits are going to start to rain down. The Armani-suited Repo Men are likely to try their luck at just about everything: tankers leaving Venezuelan ports full of oil, yes, but also the bank accounts where Venezuela is paid for those tanker loads. Citgo refineries abroad. That Russian bank Fonden half-owns. Pretty much anything Venezuela owns abroad.

 
Venezuela’s economy is too screwed up as it is to withstand any more shocks. And a credit event would be a big shock.

Of course PDVSA has overpaid lawyers of its own, so it’s going to be a fight. If you know your car is about to get repoed because you didn’t pay your installments, you might try to hide it. Put it under somebody else’s name. Paint it. Change the license plate. Get creative!

Thing is, you can be sure the guys you owe money to won’t just take that sitting down: you’re going to get dragged to court, and it’s going to be messy and slow and drawn out and expensive. And while you’re tied up in three dozen court cases, who’s going to want to do business with you?

The one-two punch of losing access to foreign credit and facing a tsunami of lawsuits from international Repo Men is terrifying. Venezuela’s economy is too screwed up as it is to withstand any more shocks. And a credit event would be a big shock.

The thing is, the key cabinet players – Del Pino, Pérez Abad, Marco Torres and co. – seem to grasp the scale of the calamity default would entail. That’s why it was an important signal when they managed to get Luis Salas – who didn’t grasp it at all – kicked out of the cabinet. They wanted to show they get the danger default poses. They are, in a way, desperate to pay.

Even the people they owe money to are staggered by their determination to pay. They’re going to beg, borrow or steal every last penny they can in the quest to keep paying. That has horrendous implications for the nation in the medium to long run, but they’re not thinking beyond November. They know if they don’t pay, the sky caves in.

But can they?

We’ll find out.

 

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