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October 3, 2013

The U.S. has never defaulted on public debt.

By Edward Gresser

THE NUMBERS: Yield on 10-year bonds, September 26, 2013* –

Switzerland 1.09 percent
Taiwan 1.69 percent
Germany 1.83 percent
United States 2.65 percent
United Kingdom 2.74 percent
China 3.98 percent
Thailand 4.05 percent
Portugal 7.07 percent
Mexico 7.75 percent
South Africa 7.77 percent
Greece 10.14 percent

* From The Economist magazine


What would it mean for the U.S. to default on debt this month? Alexander Hamilton’s Report on Public Credit (January 1790) has a useful point of departure:

“[W]hen the credit of a country is in any degree questionable, it never fails to give an extravagant premium, in one shape or another, upon all the loans it has occasion to make. Nor does the evil end here; the same disadvantage must be sustained upon whatever is to be bought on terms of future payment. From this constant necessity of borrowing and buying dear, it is easy to conceive how immensely the expenses of a nation, in a course of time, will be augmented by an unsound state of the public credit.”

Without interruption, Hamilton’s 75 successors in the Treasury Department have followed his guidance, paying the bills without interruption (with a minor but telling exception, noted below) through troubles ranging from the extinction of Hamilton’s Federalist Party in 1808 through the military occupation of Washington in the War of 1812, the Civil War, the Depression, and the Second World War. Others in the relatively small never-defaulting group include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, Switzerland and the U.K..

After these 22 decades of sobriety, ten-year Treasury bonds on sale this week carry yields of 2.65 percent – above rates for Taiwanese, German, and Swiss paper, but near the low end of the world tables. U.S. government net interest payments for 2013, meanwhile, will be about $223 billion on a roughly $16 trillion public debt. To boldly oversimplify and compare not-wholly-like things, an interest payment of $223 billion based on yields of about 2.7 percent suggests that each percentage of interest rates is the rough equivalent of $70 billion in payments.

The U.S. is unique, however, in having a “debt ceiling.” This is a financial device, invented during the First World War, which requires Congress, having authorized spending, then to enable the Treasury Department to pay for it. Conservative critics of health reform argue that refusing to raise this ceiling, despite existing financial commitments, can create political “leverage” in health-care arguments. The current “ceiling,” meanwhile, was set after a budget confrontation in 2011 and is likely to be breached in mid- to late October. At this point the Treasury would be unable to issue bonds to meet new obligations.

What then would happen? The budget confrontation of 2011 brought Congress close to a breach of the debt ceiling. Afterwards, ratings agency Standard & Poors downgraded American credit from AAA to AA+, saying that while the final agreement “removed any immediate threat of payment default posed by delays to raising the government’s debt ceiling,” nonetheless “the statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy,” and that this together with the wide gap between the parties on fiscal issues created greater uncertainty over U.S. creditworthiness. This downgrade, according to the American Bankers Association, has added nearly $20 billion to government spending on interest over the next decade. There’s no easy way to guess the penalty for a re-run with another last-second hike, but the easiest estimate would be for a bill about the same as the last time.

What would an actual default bring? Looking back during the 2011 confrontation, Donald Marron of the D.C.-based Tax Policy Center noted that a small and technical missed interest payment in 1979 (an interest payment missed for a few hours, not deliberately but because Treasury check-writing machines broke down after a late debt-ceiling increase) led to an 0.6 percent increase in interest rates lasting almost a year. Looking at more recent international experience, the last decade’s defaults and/or debt restructurings include those of Angola, Argentina, Cote d’Ivoire, the Dominican Republic, Ecuador, Gabon, Greece, Grenada, Kenya, Liberia, Nigeria, Paraguay, the Solomon Islands, Venezuela, and Zimbabwe. Greece, the only developed country in the group, now has a 10-year bond yield of 10.14 percent. An identical rate for the U.S. would imply annual interest payments of $900 billion or so, which in the $16 trillion U.S. economy can certainly be considered an “extravagant premium,” an “immense augmentation” of public spending, and an evil that, however long it lasts, ought to be avoided.


Hamilton’s Report on Public Credit, 1790:

S&P on the 2011 downgrade:

And American Bankers Association Pres. Frank Keating on the 2013 threat:

More –

The Treasury Department reports on bond yields and interest rates:

The Financial Times’ bond-yield tables for 20 countries, from Greece to Japan:

The Tax Policy Center’s Donald Marron on the unintentional but costly micro-default of 1979:

Experience elsewhere –

Argentina’s Ministry of the Economy:

The Bank of Greece:

And the financial blog Calculated Risk lists 108 sovereign defaults from 1981 to 2003, most of them small temporary events in small and unstable countries. A selection from 1998-2003 range includes Paraguay, Dominica, Moldova, Ukraine, Cote d’Ivoire, Ecuador, and Gabon: