Why the United States Cannot Default


In this post, I am not going to argue that the USA should not default because it will cause havoc in global financial markets. This — if the debt limit is not raised or abolished via a trillion dollar coin or other means by October the 17th — is a distinct possibility, but much has been said of this already. Nor am I going to argue that the United States Treasury will somehow manage to skirt defaulting via emergency austerity measures. This is possible too, though has also been discussed elsewhere.

I am going to argue that in the long run, whether the United States raises the debt ceiling or not, it is technically impossible for the United States to default. This simple fact is encoded in the Fourteenth Amendment to the Constitution:

Section 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.

While bondholders may not get their money including interest immediately, the courts will rule in their favour when the matter comes to court. The Fourteenth Amendment is absolutely clear on that. Some credit default swaps may trigger (this depends, I think, on the wording of individual credit default swap contracts, which in itself may cause further confusion) but in the end bondholders will absolutely and assuredly get their money. This means that United States Treasuries remain low-risk assets. And that — even in the event of default — should keep interest rates on Treasury debt relatively low. There will be no crushing exit of the bond vigilantes — after all, why would they choose to crash a market they are already deeply invested in if they will sooner-or-later get paid? People, generally, who buy large quantities of US Treasuries are not sitting around and reading libertarian blogs pondering the issues of dollar debasement and the end of the dollar as the global reserve currency. The latter may be a real longer term issue, and I think in the next 50 years, perhaps even the next 20 years we will see more alternative reserve currencies emerge. But that is another story for another day.

In the medium term and the short term the thing that is keeping bond buyers buying bonds is the search for yield over cash. If you have billions of dollars in cash at your disposal as many investment managers and countries do, and your imperative is low-risk yield, government debt beats cash that yields nothing, it beats commodities speculation and stock market speculation, and it beats corporate bonds as corporations are not sovereigns. A guaranteed dollar-denominated yield, even a very low one is still very attractive to treasury buyers, even if some large treasury buyers like the Chinese government have made some bond-vigilante-like noises in the past few years. These have thus far proven to be hot air, even if I have in the past made the mistake of paying too much attention to such noises.

Personally, I wish to see the debt ceiling abolished entirely, either through the absurdity of trillion dollar coins (my original objection, that authorising a trillion dollar coin would look silly has been made entirely moot by the fact that the United States Congress already looks extremely silly due to the ongoing standoff) or otherwise. At the very least, the debt ceiling should be denominated in real economic activity, not an arbitrary number of dollars, and in setting such a ceiling it should be remembered that Great Britain successfully sustained and paid down a sovereign debt of over 250%. Higher sovereign debt levels for a rich, powerful country like the United States are not dangerous. It is — as we are seeing — destructive both to markets and to society that a sovereign can be reduced to gridlock and turmoil and confusion over such a simple thing as a spending or borrowing authorisation. The real dangers here are not overspending or running out money, but unnecessary forcible austerity imposed by lawmakers, sucking money and economic activity out of the economy, and creating chaos and confusion in markets. There are already many real problems in the US economy — millions of people unemployed, weak growth, lack of job creation, private debt overhang and slow, painful deleveraging. The last thing the US economy needs is an unnecessary crisis of uncertainty and confusion created by economic illiterates in Congress.