The idea that the US cannot possibly default, at least in the sense of not being able to pay itsÂ debt obligations,Â is universally held. It helps explain why yields on US government bonds are so low despite its public debt having reached an eye-popping 96% of GDP. But is it true that the US cannot really default?
According to Richard Salsman, president of InterMarket Forecasting, it’s not. One key reason why not is America’s track record. The US has effectively defaulted before. The operative word here is “effectively”, as the US has never formally declared that it was defaulting on its debt. But if a country’s government takes steps to dramatically reduce the value of its currency and then use this cheapened money to pay the nominal amounts it owes,Â it hasÂ “effectively”Â defaulted. Creditors end up with less purchasing power than theyÂ originally lent.
AsÂ excerpted in the op-ed page of today’s Financial Post, such inflationary restructuring of debt has occurred at least three times in US history:
1. The 1861-1865 Civil War during whichÂ greenbacks were issued.
2.Â In 1933, when the Roosevelt administrationÂ passed an executive order thatÂ revoked clauses in bond contracts allowing creditors to demand payment in gold.
3.Â The coup de graceÂ that US President Nixon gave to Bretton WoodsÂ when he brokeÂ the last tie between the US dollar and gold. This allowed the US government to freely print money.Â The consequence, as Salsman points out, is that the rate of return on US bondsÂ wasÂ -56% from 1965 to 1981.
That negative performance is something to think about if oneÂ happens to beÂ pondering an investment in US government bonds.