So, this may be a stupid question but - What happens when a country defaults? What are the consequences of that?
The major problem that is facing Greek citizens these days is that because the Greek government's hands are tied in monetary things, the country cannot achieve its full potential.
Since Greece was a net importer for a long time, money has been leaving the main part of the Greek economy [1]. Now Greeks no longer have as much money to afford imports - which would be only fair in some sense - but worse than that, they no longer have money to pay each other. This is what causes the very high unemployment in Greece.
Now you would say, if you have person A who would like to sell to person B, and person B who would like to sell to person A, and neither of them have any money, they could still do their transaction, and so not having any money to pay each other is not a problem. That is true in this very simple scenario.
The real modern economy is much more complex than that, and situations where two people genuinely just trade with each other almost never occur. So Greece has become stuck, people are unemployed, which means that the country is not reaching its productive potential.
By re-introducing its own currency, the Greek government could restart the spending cycle.
It is without doubt that a new Greek currency (NGC) would immediately drop in value compared to other currencies. There is nothing that can be done about that, and it is the reason why a reintroduction of NGC needs to go along with a default (or a technical default where the debts are revalued once in NGC, so that the exchange rate no longer matters).
It is also true that the short-term pain for Greeks would not go away immediately. Imports would be very expensive in NGC and difficult to afford, but this is not that much different from the current situation where imports are difficult to afford because the money is missing.
Most importantly, the Greek government would be able to introduce an economic expansion program to put people to work, so that the real capacity of Greece itself would be used fully to the benefits of Greek citizens.
Edit: I should add that this scenario has already played out in the case of developing countries and particularly many times in South America, e.g. in Argentina.
[1] Of course, there are also very rich Greeks. However, they save their money and don't invest in Greece at this time (because the economy is bad), so their money does not enter into the picture.
You'll note the current entry, 4th July 2011 is "10 Things you must know about Home Invasions" proceeded by "Survival Kits" and a little further down "Armoured Vehicles", or perhaps if you're interested in how business is conducted after such a collapse you might read this article about doing business in Argentina-
http://www.inc.com/magazine/201106/doing-business-in-argenti...
There is at least a clear correlation between defaulting and subsequent growth of the economy, and there is a very plausible theoretical reason (roughly outlined in my earlier post) that this connection is causal: defaulting and free-floating currency is what allowed Argentina to return to a path of growth.
This does not mean that things will be perfect immediately or even 10 years later. It just means that - assuming responsible economic stewardship - the country can go back to fully realizing and growing its potential.
Plus you also have those that have insurance against a sovereign default, largely through credit default swaps (CDS). However unlike many forms of insurance, you don't need to actually own the bond to take out a CDS on it. In this way many people will trade the risk of a Greek default without actually going anywhere near the physical asset. Being a derivative product, the size of the CDS market on Greek debt is likely to be many, many, many times greater than the size of the underlying basket of bonds.
So if Greece defaults - or even "technically" defaults, which could include the proposed rollover into longer-dated bonds - this could have huge implications for people who are short this insurance. They're all going to have to pay out.
Apart from the direct financial impact, with Greece you have the additional embarrassment and complication due to being part of the Euro. Greece may be forced to leave the single currency, which is going to be a costly and messy exercise, and severely damage the reputation and credibility of the currency.
Also, like Greece is now, the country has to have massive public service cuts, and tax hikes. Have the republicans been asked about the possibility of this?
What happens when a company defaults on its debt? Its rating goes down, reputation is hurt, etc. Same deal, except it's more global with a country.
Why are people freaking out on the US, Greece and Spain?
Sorry, I'm totally unfamiliar with these things.
People come up with this 55 trillion dollar numbers by adding in future social security-type outlays, which are always paid out of the current budget. These types of numbers are a form of FUD which is spread by ideologues.
Think about it this way. Suppose you rent an apartment for 1500$ per month, and expect to live in it for the next 10 years. If you follow the logic of the people who claim a 55 trillion debt, then you would claim that you now have a debt of 180,000$.
We all know that that claim is ridiculous, but unfortunately, the same flawed logic is slightly harder to detect and unravel when it comes to something as complex as the entire economy.
That "out of their current budget" is irrelevant. Most people who buy a house on mortgage pay of their debt out of their current budget, too. A mortgage still is a debt, though (ideally (more than) balanced by the worth of the property you bought for the mortgage)
The U.S. has defaulted before, in 1933, but this would still be considered a very significant event in global economics, and economists really don't need another reason to get nervous right now.
There is, by the way, an interesting elephant in the room that I've yet to hear mentioned anywhere: once we've gotten to the point that people start discussing the possibility of simultaneous defaults of several major countries, nobody's really sure what will happen next, and, nobody's really sure how to get out of the hole, since we've never been in this deep before.
So it's defaulted.. and look where it is now.
If Greece looks to the US as a model it should default, and the sooner the better.
"Because a default ... can affect its credit rating and, in turn, its ability to continue borrowing..."
Borrowing is what got Greece in trouble in the first place. Perhaps putting and end to borrowing from other countries would put it on a sounder financial footing. At least it would never again get in to the situation where many future generations would be forced to repay the debts of their ancestors.
In the end, hard measures will have to be taken so that trust can be restored.
Hence bonds are a risk-averse investment, and so bond holders are very jumpy about default.
The Greek bonds, IIRC, before the CDS rates (credit default swap: basically a bet on the chance of a bond going into default) started creeping up, were issued at around 3% coupon. This value is consistent only with a very low perceived risk of serious default by the buyers of bonds. At the moment, CDS markets are showing a near probability of Greece going into default: the bond rates are artificially low only because of massive government and IMF intervention in the markets.
Note also that even after the drastic austerity measures, Greece is still running a budget deficit, so if it defaults, it cannot finance its expenses even in the short term.
Greece is small fry, but it is seen as a test case for bigger countries: probably Spain, possibly Italy. Actually, the situation is worse in Portugal than Greece, since Portugal is also insolvent and has shown nothing like the political resolve that Greece has. But Portugal is tiny.
Many of the banks in wealthier European countries are heavily exposed to PIGS (Portugal-Spain-Ireland-Greece) debt, so expect serious PIGS defaults to be followed by rich country bank crises. German banks, in particular, are badly exposed to Spanish government debt. The "stress tests" of European banks carried out in 2010 explicitly did not test for sovereign default, presumably to avoid frightening bond holders.
Default is any failure to pay the full amount of the coupon on a bond on time, where the coupon on a bond is the specification of which sums of money are payable when.