Has the US Ever Defaulted on its Debt?

Sec. Janet Yellen and President Joe Biden recently declared that the US always pays its debt. But has it really? In this article I take a look at what default is and offer a series of examples where the US has indeed defaulted on its debt.

Default occurs when a borrower fails to repay a debt including interest or principal on a loan or security. A default can occur when a borrower is unable to make timely payments, misses payments, or avoids or stops making payments. It can apply to individuals, corporations, and even countries.

Now, let's try to explain the process and implications of default.

The Process of Default: When a debtor has a loan, they're required to make regular payments to the creditor. These payments typically include both the principal (the original amount of money borrowed) and interest (the cost of borrowing that money). If the debtor fails to make these payments for a certain period of time, they're considered to be in default.

Consequences of Default: The consequences of default can be severe and wide-ranging. For individuals, defaulting on a loan can result in legal action, damaged credit ratings, and loss of assets. For corporations, default can lead to bankruptcy and liquidation. For countries, default can trigger a crisis of investor confidence, a sharp increase in borrowing costs, and economic instability.

The Role of Credit Rating Agencies: Credit rating agencies play an important role in assessing the likelihood of default. They rate debtors on their ability and willingness to pay their debts. A lower credit rating suggests a higher risk of default.

Default and the Economy: Defaults can have significant impacts on the wider economy. For example, during the 2008 financial crisis, a wave of mortgage defaults in the US led to a global recession. Similarly, sovereign defaults (when a country fails to pay its debts) can trigger regional or even global economic instability.

Risk Management and Default: Lenders use various methods to manage the risk of default. These can include careful evaluation of a potential borrower's creditworthiness, requiring collateral for a loan, and diversifying their lending to spread risk.

Defaults are an integral part of the economic system, they show the risk inherent in lending and borrowing activities. However, they can also lead to significant disruptions in financial markets and can be a sign of underlying economic problems. Do you think we have any underlying economic problems in the United States?

The U.S. federal government has technically defaulted on its debt obligations a few times in our history.

1. During the Civil War in 1862, the U.S. federal government issued fiat paper currency known as "greenbacks" to finance the war effort. These notes were not backed by gold or silver, which led to inflation. The government also passed the Legal Tender Act, declaring that these greenbacks were legal tender for all debts, public and private, except for interest on government bonds and duties on imports, which were still required to be paid in gold. This meant that creditors were forced to accept a currency that was less valuable than the gold or silver they were expecting, which can be interpreted as a form of default.
2. In the midst of the Great Depression in 1933, President Franklin D. Roosevelt issued an executive order banning the private ownership of gold, requiring all gold to be sold to the Federal Reserve. Furthermore, the government refused to redeem dollars for gold and eliminated the gold clause in all contracts, both private and government. The gold clause guaranteed that creditors could demand repayment in gold rather than in dollars. Let me repeat, the United States had in clear and entirely unambiguous terms promised the bondholders to redeem these bonds in gold coin. Then it refused to do so, offering depreciated paper currency instead. By eliminating this clause, the U.S. government effectively reduced the value of repayments, which is also sometimes interpreted as a form of default.
3. In March 1968, in response to a run on gold, the U.S. and other leading economies decided to create a two-tier gold market under the auspices of the "Gold Pool" arrangement. In the official tier, central banks would trade gold among themselves at the fixed price of $35 per ounce, but they would no longer buy or sell gold in the private market. In the private tier, the price of gold would be determined by supply and demand.?By refusing to honor its explicit promise to redeem its silver certificate paper dollars for silver dollars. The silver certificates stated and still state on their face in language no one could misunderstand, “This certifies that there has been deposited in the Treasury of the United States of America one silver dollar, payable to the bearer on demand.” Hence another example of default.
4. However, this arrangement proved to be unsustainable, and in 1971, President Richard Nixon announced that the U.S. would no longer convert dollars to gold for foreign central banks, effectively ending the Bretton Woods system. This period is known as the "Nixon Shock." U.S. government broke its commitment to redeem dollars held by foreign governments for gold under the Bretton Woods Agreement. Since that commitment was the lynchpin of the entire Bretton Woods system, reneging on it was the end of the system. Although President Nixon announced this act as temporary: “I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold.” The suspension of course became permanent, allowing the unlimited printing of dollars by the Federal Reserve ever since.
5. In late April and early May of 1979, the U.S. Treasury failed to redeem $122 million of Treasury bills, which are short-term debt instruments, on time because of problems in processing the paperwork. These delays were exacerbated by a backlog created by a temporary shutdown of the federal government. The Treasury Department did eventually make all the payments with appropriate interest, but the incident is often cited as a technical default because of the delay in payments.

Some may argue that while these events represented a major shift in global monetary policy, they did not constitute defaults, as the U.S. government continued to meet its debt obligations with paper money of less purchasing power, but paper money none the less. The U.S. government's consistent payment history, combined with the size and strength of the U.S. economy, has led to U.S. Treasury securities being considered one of the safest investments in the world. This is why the U.S. has maintained a very high credit rating, despite carrying a large amount of public debt. So when our leaders say, "The US always pays its debt" remember this as well, its with paper money that fails to retain its purchasing power over longer periods of time.