Yes, the last paragraph is pretty much the system every country uses. Look at the UK, for example, where the national debt continues to rise - there is no real plan to pay it off - the system is designed in such a way that overall debt issuance must rise in order to service older debt. It's a horribly unstable system, but unfortunately we seem to have embraced it across the world.
Suppose all the sovereign debt defaults and is restructured to be 5% of
the original. Who loses?
Mostly the holders of treasuries. Holders of other assets would seem to be fine!
So it seems to me to be like any other default, except on a larger scale. Price the sovereign debt risk into the calculation and diversify into real assets.
The problem is that a sovereign default increases the cost of capital for pretty much everyone in a nation. This generally results in a decrease in lending, and kills any markets that are dependent on lending (housing being a big one).
Basically, once the bankers have inflated financial bubbles everywhere, the impending crash is bad for the common man, UNLESS you're one of the lucky individuals that somehow became cash rich during the bubble, and can use the cash to buy up while the market/lending falls to pieces. Funnily enough, the cash rich ones seem to be the bankers, who, laden with bonuses from the bubble days, buy up property which they can rent to plebs to get a comfortable 6-10% pa return.
In the United States, defaulting on Sovereign Debt would basically guarantee the death of social security. If you're in the USA, by far the best way you can insulate yourself against sovereign debt is by:
1) organizing your life's expenses so that you can retire (or at least continue to live) with $0.00 from social security.
2) Ensuring that you don't rely on any federal pension (including military retirement).
Of course, that isn't possible for most people. So in the USA, the answer to "who loses?" is "old people".
3) Ensuring you will have be able to afford healthcare in old age without medicare.
So lets the the economy has $X trillion (nominal) of real assets. You privatize social securities $Y trillion assets with the stroke of a pen. You now have $(X+Y) trillion chasing the same real assets.
The rate of return on those assets will decline in proportion to the new money chasing them. On the margin, (and more so over time) new productive opportunities will occur as the cost of capital to business declines, but in the short run all you are doing is inflating a bubble.
SS and other entitlement/retirement programs hold a monstrous amount of the total federal debt. I doubt the federal gov't could divest even a small fraction of those securities without destroying market for them.
The problem with sovereign debt is that it is likely to be inflated away instead of getting restructured. As a result, all lenders lose, borrowers win, all holders of risky assets lose as risk premiums go up. To make things worse, inflation makes its way through the economy unevenly, distorting prices and leading to misallocations of resources.
