Yellen Is Wrong: The US Government Doesn’t Always Pay Its Debts
The regime is trying to whip up maximum hysteria or the chances that the US government could default on its debts if the debt ceiling is not raised.
So far, the financial markets don’t seem to care that much, as ten-year Treasurys over the past week have barely risen above 1.5 percent, and not even matched last March’s recent high. Investors seem pretty confident that the world will still exist even after default.
But the media and Democratic politicians assure us that any default will bring about a second Great Depression and financial collapse.
One key component of this strategy is convincing people that the United States has never defaulted before, and has always made good on its financial obligations. This is key because it helps create the impression that were the United States to default, the result would a step into the great unknown, and a “financial crisis and a calamity.”
This is likely (in part) why, in her September 19 column for the Wall Street Journal, Treasury secretary Janet Yellen repeatedly claims the US has never defaulted. “The US has always paid its bills on time,” she insists, and then repeats the claim in the next paragraph: “The US has never defaulted. Not once.”
Yet the United States government absolutely has defaulted on debts before—more than once. Moreover, if we expand the idea of default slightly, to encompass the idea of inflating away a government’s debt in real terms, default is even more common.
First, let’s look at the most notorious case of US default on its debt obligation.
The 1934 Default on Liberty Bonds
In 1934, the United States defaulted on the fourth Liberty Bond. The contracts between debtor and creditor on these bonds was clear. The bonds were to be payable in gold. This presented a big problem for the US, which was facing big debts into the 1930s after the First World War. As described by John Chamberlain:
So how did the US government deal with this? Chamberlain notes “Roosevelt decided to default on the whole of the domestically-held debt by refusing to redeem in gold to Americans.”
Moreover, with the Gold Reserve Act of 1934, Congress devalued the dollar from $20.67 per ounce to $35 per ounce—a reduction of 40 percent. Or, put another way, the amount of gold represented by a dollar was reduced to 59 percent of its former amount.
The US offered to pay its creditors in paper dollars, but only in new, devalued dollars.1 This constituted default on these Liberty Bonds, since, as the Supreme Court noted in Perry v. United States, Congress had “regulated the value of money so as to invalidate the obligations which the Government had theretofore issued in the exercise of the power to borrow money on the credit of the United States.”
This was clearly not a case of the US making good on its debt obligations, and to claim this is not default requires the sort of hairsplitting that only the most credulous Beltway insider could embrace.
Indeed, Carmen Reinhart and Kenneth Rogoff in their book This Time Is Different list this episode as a “default (by abrogation of the gold clause in 1933)” and as “de facto default.”2
The Short Default of 1979
A second, less egregious case of default occurred in 1979. As Jason Zweig noted in 2011:
Apparently, the United States sometimes does not pay its debts. While the 1979 default was relatively small, the 1934 default affected millions of Americans who had bought Liberty Bonds mistakenly thinking the government would make good on its promises. They were very wrong.
So, it is simply untrue that the US “has never defaulted. Not once,” as Yellen claims. But this claim remains a useful tactic in sowing fear about “unprecedented” acts that would bring the entire US economy crashing down.
Default through Devaluation
But outright repudiation of contracts is only one way of defaulting on one’s obligations. Another is to deliberately devalue a nation’s currency—i.e., inflate it—so as to devalue the amount of debt a government owns in real terms.
And Zweig writes investors view this as a real form of avoiding one’s debt obligations:
This strategy, Zweig concludes, “stiffs bond investors with negative returns after inflation.”
Zweig categorizes this as something separate from default, but Reinhart and Rogoff clearly consider it a form of de facto default. They write: “The combination of heightened financial repression with rises in inflation was an especially popular form of default from the 1960s to the early 1980s” (emphasis added).3
(In the United States, a key event in this respect occurred in 1971 when Nixon closed the gold window. This was an explicit repudiation of the US’s obligation to repay dollars in gold to foreign states, and it also greatly enabled the US government in terms of financial repression and monetary inflation.)
Since the Great Recession, financial repression is popular again. This method of de facto default has enabled the federal government to take on massive amounts of new debt at rock-bottom interest rates. In real terms, the US government—or any government using this tactic—pays back its debts in devalued currency, essentially enabling the government to make good on the full extent of its debts. The cost to the public manifests in asset price inflation, goods price inflation, and a “hunt for yield” driven by a famine of income on safe assets. Americans of more modest means are those who suffer the most, and the result has been a widening gap of inequality in wealth.
It may very well be that a default could lead to significant economic and financial disruptions. But let’s stop pretending that a default is unprecedented or that the United States always pays its bills. It’s true that the US’s current debt machine, enabled through financial repression, is a form of slow-motion default. But that doesn’t make the US government any less of a deadbeat.
Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Send him your article submissions for the Mises Wire and Power and Market, but read article guidelines first. Ryan has BA degrees in economics and political science, and an MA in political science from the University of Colorado. He was a housing economist for the State of Colorado. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.
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