why no one talks about it, although it has already happened five times
The dollar and the US government debt are cited in all financial textbooks as an example of a “risk-free” asset with the highest reliability. But not everyone knows that Uncle Sam defaulted more than once, or even twice. In this article, we will dive a little into the financial history of America, and also find out how real the threat of US default is now.
I have a category #ReasonableAnswer , where I briefly answer readers’ questions. The answer to the last sent question turned out to be a little longer – and I decided that it was worthy to be published as a separate note. Below is the uncut question.
Not so long ago, Patrushev announced that the United States is waiting for a default. This assumption was accepted by many with skepticism, let’s say; although everyone knows about their public debt. And what really needs to happen for the States to default? Is it possible that they can’t print a bunch of new bucks or issue a bunch of new receipts to pay off the old ones? And what consequences will this have for the world/Russia?
Ilyas, subscriber Rational Answer
First, let’s remember what is default: Contrary to popular belief, this is by no means exclusively a complete and irrevocable refusal to pay anything on a debt. For a default, it is enough to violate any obligations assumed under the debt agreement: for example, to pay not quite on time, in the wrong currency, or, in principle, at least do something that is contrary to the loan agreement.
Default in your currency: a trick for the gifted
In general, for a country to default on debt denominated in its own currency, it needs to show a rare hand-to-hand. Yeltsin in 1998, by the way, did it dofirmly and clearly collapsing the pyramid of GKOs (government short-term bonds).
Yeltsin tried to show the miracles of financial acrobatics there: at the same time to sit on two economic chairs with different half-drinks – and maintain a fixed exchange rate of the ruble against the dollar, and at the same time plug a growing hole in the budget with money “out of nowhere”. In the end, something in the financial body of the state tragically cracked, and payments on the state debt in rubles were frozen. Then, of course, everything was returned – but during this time the exchange rate of the ruble against real (green) money managed to depreciate four times.
Why is defaulting on debt in one’s own currency such a strange and rare thing? It’s simple: in the worst case, a country can always print cut paper (and now – cut zeros and ones) in the required volume – thereby depreciating its currency, and at the same time its debt. Therefore, being a world hegemon, in whose currency everything is invested in a row as a reserve (I say hello to America!) Is a very profitable and pleasant occupation in a financial sense.
In the United States, of course, every few years they play out a DRAMA about the struggle around raising the legally approved limit on the total amount of public debt (the so-called Debt Ceiling, the “debt ceiling”), into which this very unfettered debt periodically ceases to fit. But this is not particularly related to finances – rather, let’s say, to the political theater (well, or even to the circus).
Special default transactions
But let’s move on to the promised star-striped defaults.
Actually, as soon as it was born, the United States immediately tried to do this very thing: shortly after the victory in War of Independence, the newly hatched United States of America assumed the debts of the former Disunited States in 1790. But at the same time postponed payments on these debts for 11 years. Which kind of looks like a default; but on the other hand, they could not take on anything at all! So this default turned out to be like a toy, rehearsal – we will not consider it in the overall standings.
And here’s where it gets interesting. When, after 70 years, began Civil War, to finance the US military operations in 1861, they issued green notes with reliable gold backing. And already in 1862, they retroactively decided to “annul” the right to exchange these banknotes for gold.
The waste paper holders did not like this very much, and they abruptly rushed to the US Supreme Court, which declared this topic completely unconstitutional (where has it been seen – to change the terms of debt obligations retrospectively?). But here the then president of America could not stand it: he urgently supplemented the “wrong” judges with the necessary number of “correct” ones – and the re-convened Supreme Court found absolutely no problems with such retrospective feints. Long live the fairest court in the world!
The spool is small, but expensive (that’s why we won’t give it to you)
The trick with disappearing gold was repeated by the US government again in 1933, when it denied the holders of “gold bonds” the right to redeem their gold coins. Roosevelt then so selflessly fought with great depressionthat, instead of gold, he suggested that investors be content with redemption in the form of green papers with dead presidents painted on them.
Despite the fact that this obviously contradicted the prescribed terms of the bond loan, this time the Supreme Court upheld the rightness of the state already from the first approach to the projectile (apparently, the judges concluded from the last time that arguing with the President of America is such a thing) . U.S. Supreme Court Chief Justice Charles Evans Hughes (who upheld the constitutionality of the default) is said to have then spoke out in the style of “something we just decided some immoral crap; but, thank God, that everything is according to the law!!”
The government of America was so pleased with throwing its (and other people’s) citizens with various promises of precious metals that they turned this attraction (without significant changes) two more times.
First, in 1968, the US refused to exchange paper dollars for silver, on which it was literally printed “this thing can be exchanged on demand for silver!”
Well, then the United States generally went for broke and in 1971 completely canceled all Bretton Woods system, according to which any foreign states could present a paper dollar to the States for its exchange for gold. President Nixon then, by the way, announced that this exchange was “temporarily suspended.” And indeed, they suspended it so temporarily that for 50 years they still cannot resume it …
When other developed countries, looking at this, politely asked “Hey guys, you didn’t do anything wrong there, by any chance?”, US Treasury Secretary and Texas native John Connally answered to this with the famous phrase: “The US dollar is our currency and your problem…”
In 1979, the States managed to do something strange in general: they admitted technical default on its short-term bills. Yes, yes, according to those great and terrible, ultra-reliable US Treasury Bills – which any textbook of finance always calls by default a “risk-free asset”.
They say that there was some kind of “office move” or some other excuse – but the fact is that checks for $122 million in interest due to holders ended up arriving three weeks late. And the Ministry of Finance even had to pay people interest for late interest! (True, only those who guessed to sue the Ministry of Finance itself.)
Brief conclusions: what about the US public debt?
So, we have found out that the States have reliably defaulted at least five times in history. Why does everyone still consider the US national debt the most reliable haven in the world for their capital?
As you can see, almost all of the defaults described above (except for one technical default, which was made out of sheer curiosity) are associated with the inability to exchange a dollar for something else that is not a dollar. In the case of America, it was all the time about precious metals (which you simply cannot print if necessary) – well, other countries, as a rule, declare a default when they cannot pay off their international debts in a foreign currency (in the same dollar, for example).
So to fear that the US will suddenly lose the financial ability to pay for its issued US Treasury Bills/Bonds is not the most reasonable thing. True, this year it suddenly became clear that at some point America could lose a wish to pay off such debts – at least to “unfriendly” countries.
And now, all over the world, heads of state are sitting and thinking: “What if the Americans also recognize me as disloyal tomorrow and freeze all reserves?” It seems to be scary, but there is nowhere to go – to whom will you entrust your hundreds of billions? Invest in a depreciating euro at a negative interest rate? Or maybe you’ll drink yuan to the Chinese (they definitely won’t be deceived, ha ha)?
That’s how everyone lives, in short. And you’re talking about the default…
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