“The United States of America is never going to default, that is never going to happen,” said US Treasury Secretary Scott Bessent on June 1. History suggests that, when it comes to defaults, politicians should never say never.
Bessent’s comment was intended to reassure market participants following a sharp run-up in long-term Treasury yields and a Moody’s downgrade of US federal government debt. But the very fact that Bessent thought it necessary to reassure prospective Treasury bond buyers on this point probably gave them pause.
It is certainly not unheard of for a Treasury Secretary to raise the topic of default. For example, in 2023 Janet Yellen said that the US should never default on its debt. The consequence of such an event, she warned, would be “an economic and financial catastrophe.”
A default by the US government would also shatter precedent, according to the former Treasury Secretary. As she put it, “Since 1789, the United States has paid all our bills on time.”
Or so she claimed. But in reality, the country’s record on meeting its financial commitments is not quite so immaculate.
Here are a few instances over the past two and a half centuries when the US government did not quite deliver what it promised.
In 1814, the financial burden of the war with Great Britain prevented the Treasury from scrounging up enough cash to service its debts. “The dividend on the funded debt has not been punctually paid,” Alexander J. Dallas, the sixth US Treasury Secretary, acknowledged. “A large amount of Treasury notes has already been dishonored.”
In 1862, the costs of fighting a war once again strained the US Treasury. In response, the government paid its bills by printing pure paper money, so-called “greenbacks,” at a time when the dollar was still legally pegged to gold. During the Civil War, the greenback depreciated sharply versus gold whenever the Union army suffered a setback.
And then there was the abrogation of the gold clause. Up until Franklin D. Roosevelt’s presidency, Treasury bonds were sold with a contractual clause stating that holders could demand payment in gold. However, a joint resolution of Congress revoked that clause on June 5, 1933, and the Supreme Court upheld the Congressional action on dubious legal grounds.
There have been a few other instances, including the government’s refusal to redeem ‘silver certificates’ for the precious metal beginning in 1963 and a computer glitch in 1979 that caused promised payment to be delayed.
MONETARY MISCONCEPTIONS
The mistaken belief in a spotless US credit record is unsurprising given widespread misconceptions about sovereign debt.
For example, Modern Monetary Theory, a school of thought that gained many adherents in the years leading up to the pandemic, posited that a country never had to default on debt denominated in its own currency because it could simply print more money to meet its obligations.
While this might be true in theory, it certainly isn’t in practice. To cite one comparatively recent counterexample, Russia defaulted on its ruble-denominated bonds in 1998.
What is more accurate to say is that no bankruptcy process exists for sovereign nations comparable to bankruptcy codes for corporations, but sovereign defaults remain a risk.
So where does this leave the US debt situation today? On the positive side, the US is nowhere near the brink of default. However, with US debt to GDP above 120 per cent and rising, the notion of a default can no longer be dismissed with a derisive laugh.
Whether that calamity can be avoided over the long term will depend on Congress finding the political will to stop the government’s outlays from galloping ever further ahead of its income.
Investor concern about the increasing danger of default over time is suggested by the recent behavior of Treasury bonds of various maturities.
The yield on 30-year Treasury bonds soared from a low of 4.43 per cent on April 4 to a peak of 5.09 per cent on May 21, as anxiety about the US deficit grew with the emergence of more details about the Trump Administration’s tax and spending bill. Over that interval, the 30-year Treasury returned -9.39 per cent. Treasury performance improved as maturities shortened, culminating in a positive return of 0.50 per cent for 90-day Treasury bills.
A similar correlation between maturity and performance can reasonably be expected if the recent Treasury market rebound reverses.
And speaking of what to expect, if fiscal matters ever do get to the point where the US actually does default on its debt, you can be sure that whoever is Treasury Secretary will insist, right up to the end, “That has never happened before, and it will not happen now.”