When it comes to a U.S. debt default, never say never

Reuters

a day ago

NEW YORK, June 11 - 'The United States of America is never going to default, that is never going to happen,' said U.S. 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 U.S. 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 U.S. 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 U.S. 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 U.S. 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 U.S. 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 U.S. 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.
The mistaken belief in a spotless U.S. 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 U.S. debt situation today? On the positive side, the U.S. is nowhere near the brink of default. However, with U.S. debt to GDP above 120% 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% on April 4 to a peak of 5.09% on May 21, as anxiety about the U.S. 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%. Treasury performance improved as maturities shortened, culminating in a positive return of 0.50% 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 U.S. 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.'
(The views expressed here are those of Marty Fridson, the founder of FridsonVision High Yield Strategy. He is a past governor of the CFA Institute, consultant to the Federal Reserve Board of Governors, and Special Assistant to the Director for Deferred Compensation, Office of Management and the Budget, The City of New York).
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