A History of US Debt Defaults

Many mainstream pundits have been saying that the US hasn’t ever defaulted. This hardly represents the accurate picture of reality.

Austrian economist Joseph at the Mises Blog cites a work of another economist who noted of the previous US experience.

Ohio State economist J. Huston McCulloch actually challenges the conventional wisdom that the U.S. government has never, ever defaulted on its debts. McCulloch points out that the U.S. did indeed default on its debt in 1861 and again in 1933.  In 1861, the U.S. Treasury issued “United States Notes” to aid in financing the Civil War. These Treasury notes, known colloquially as “Greenbacks,” promised to pay the  bearer in “lawful money,” gold or silver at the government ‘s discretion, on demand. At the end of 1861, however, the government renounced its promise and suspended redemption as of January 1, 1862, putting it technically in default until 1879 when the notes were again made redeemable in gold. In 1933, President Roosevelt reneged on the promise to pay the interest and principal on Treasury bonds in gold at the rate of $20.67 per ounce, which once again put the government in technical default. In 1935, the right to redeem the bonds in gold was restored to foreign bondholders only, but at the depreciated rate of $35.00 per ounce, an option which was never offered to U.S. bondholders.

More important, the whole notion that an honest and explicit debt default by the U.S. government is an unprecedented event and the worst possible outcome in the current situation is ludicrous given that the U.S. has been continually and surreptitiously defaulting on its debt since World War 2 via inflationary finance. As McCulloch argues:

Governments often effectively default on their debts through inflation. Under a fiat money regime, they can always print enough legal tender money to pay off their debts. The only catch is that the money will not be worth as much as it was before. If it tries to cover too much deficit spending in this manner, more than a few percent of GDP, the inevitable result is hyperinflation in which money quickly becomes virtually worthless.

Disastrous though an explicit Treasury default would be, bringing down the entire economy with a hyperinflation or even a partial inflationary default would be even worse. But if we keep charging current deficits to future taxpayers at our current rate, the inevitable result will be a revolt in which they either explicitly repudiate all or part of the debt, or, worse yet, inflate it away.

Even the Wikipedia, as shown above, has an account of the history of US debt defaults as I previously posted here

Of course relationships have materially changed. This means that the effects of the previous defaults may or may not be the same as today.

However populist politics, which has been deeply immersed in the culture of debt, have used the default bogeyman as leverage to spook the markets in order to impel for the raising of the debt ceiling. Raising the debt ceiling means to persist on the path of a debt financed spending splurge. 

But this would be tantamount to playing with fire.

As I previously pointed out, the likelihood is that a debt deal will be struck perhaps in the last minute of the deadline, as politicians will hardly be fighting for principle, but for social standings and the maintenance of political privilege. Importantly a default would likely mean the end of the US dollar hegemony.

Proof of this can be seen in the recent editorial by the Chinese state press agency, Xinhua, which even called for the de-Americanization of the world where they claim that “effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant U.S. dollar”

Nonetheless given the path of unsustainable debt absorption by the US government…

…which has also been reflected on the entire US political economy, the issue of default, directly (restructuring or repudiation) or indirectly (via massive inflation) is a question of when and not an if. 

This means that US politics should reform the system even at the cost of temporary instability, to prevent the day of reckoning.