Hasn’t the U.S. defaulted before?
That’s the question raised by James Grant in a Washington Post op-ed, and his answer -- as anyone who knows Grant might expect -- is yes.
His real point is that it happens all the time, in a way, and will inevitably happen in the future. “On the authority of the chairman of the Federal Reserve Board,” he writes, “the government means to keep right on shirking, dodging or trimming, if not legally defaulting.”
It’s an important issue, because of how many Republican congressmen seem to think a default on the U.S. debt wouldn’t be a big deal. But there are defaults and defaults, and Grant isn’t talking about the default staring us in the face just now.
Grant founded the authoritative and always entertaining Grant’s Interest Rate Observer in 1983 (good Lord, has it been 30 years already?) and since then has been the most penetrating analyst of the foibles of central banks here and abroad.
Grant’s work is always well informed by history, and Friday’s essay is no exception. He points out that the U.S. was born in default: In 1790, the nation was delinquent on $11.7 million in foreign debt. Treasury Secretary Alexander Hamilton paid the arrears and got us out of the hole. In doing so, he cured a default.
Franklin Roosevelt staged what Grant represents as some rather defaultlike maneuvers, which I’ve also covered in my book on the New Deal. One was his overt manipulation of the price of gold in 1933, a device aimed at at taking the U.S. off the gold standard, which was hampering recovery from the Depression. (The gyrations this produced in the gold price prompted John Maynard Keynes to remark that Roosevelt had put “the gold standard on the booze.”)
The second was FDR’s repudiation of a clause in Treasury securities allowing them to be redeemed in gold. This may not have been a technical default, but as Grant observes it was treated as one overseas.
Neither of these actions, taken to protect the U.S. from the ravages of the Depression, produced lasting doubt about the stability of U.S. debt. And as Grant observes, U.S. monetary policy has consistently worked to pare the real value of Treasuries over time by promoting low, even negative interest rates on Treasuries which mean that the interest paid doesn’t cover the loss in value of the principal after inflation.
This is good for the Treasury, bad for bondholders. but it works because bondholders are still sure that on coupon dates (or reasonably close thereafter) and upon maturity they’ll get their money.
The consequences of a default caused by the debt-limit standoff might be very different, which Grant doesn’t fully acknowledge. “If today’s political impasse leads to another default, it will be a kind of technicality,” he writes. “Sooner or later, the Obama Treasury will resume writing checks.”
Is it just a technicality? The world of finance is very different today from what it was in 1790 or 1933. A towering edifice of transactions is built upon the confidence in Treasuries that would be shaken by a default provoked by Congress. Maybe the system would recover quickly, maybe not. Maybe the doubts about the U.S. as a financial partner would persist for years or decades. We won’t know unless it happens, and that alone is an argument for not trying to find out.
