The History of U.S. Defaults
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The History of U.S. Defaults


WASHINGTON - February 25, 2019

Circumstances have arisen repeatedly in which the United States Treasury has been unable to pay its obligations in a timely manner, or the terms of payment have displeased creditors. This led to an extremely high burden on the state budget and undermined government authority. However, there were cases where before a default was announced, it was possible to refinance the debt.

It's necessary to discern between an ordinary default, which indicates the state bankruptcy, and a technical default, where the borrower fails to fulfill the contract terms but there is the possibility of its execution in the future. In U.S. history, a technical default has been declared several times.

The 1790 Default

The first de facto American default occurred shortly after the country’s founding when the first President George Washington implemented the program of the Secretary of the Treasury Alexander Hamilton.

As part of this program, the government restructured congressional debts accumulated during the war for independence and issued new federal loan bonds. These were the so-called "continental dollars" with $241 million in output and the responsibility of each state to pay for them, which the States could not afford. In 1779, Congress announced their devaluation at a ratio of 38.5 to 1 and then agreed to buy their papers for 1% of face value. In fact, it was a default.

The 1861 Default

Until 1861, the United States didn't have a single banknote system, and operations were often carried out by means of metals — gold and silver bars and coins. As a single controlled payment instrument didn’t exist and after the outbreak of the Civil War the country needed a significant amount of money, on July 17, 1861, the U.S. Treasury Secretary, under the influence of Congress, issued bonds in the amount of $60 million. The use of green paint on the back of the banknotes gave rise to the name “greenbacks.”

Initially, the free conversion of new banknotes into gold in a one-to-one ratio was assumed, but in 1862 the Treasury refused to buy them on such terms. After that, dollars became legal tender, which were not repayable on demand but changed to gold with a discount of up to 50%. In fact, these actions can be regarded as recognition of insolvency, but technically a default didn't take place. Only the restriction of greenbacks and the victory of the Northern States in the Civil War led to an increase in their prices until parity with gold in 1887.

The 1933 Default

In 1933, Franklin D. Roosevelt assumed the President’s office. The country's economy was destroyed and the situation required urgent measures. One of the most extraordinary presidential decisions was related to the U.S. government bonds issued many years ago. Back in 1917, after the entry into the First World War, the U.S. Congress adopted the first and second acts of the so-called liberty bonds (or liberty loan, military bonds are debt securities issued by the government to finance the war). It's the second law on freedom bonds that is the legislative foundation of the current mechanism of functioning of Treasury bonds. Thus, the U.S. Treasury was able to issue long-term and short-term debt up to a certain period, whereas previously it was required to request special permission from Congress for each transaction.

By 1918, $7 billion of liberty bonds were issued, which, in fact, ensured the conduct of the war. The issue terms included a clause, according to which the repayment of these bonds was to be made of gold. However, the volume of unpaid liberty bonds significantly exceeded the gold country reserves. At President Roosevelt’s request, Congress passed a "Joint Resolution to assure uniform value to the coins and currencies of the United States of America," which denied American holders the payment of gold, which devalued the dollar by 40% compared to foreign currencies. In fact, such a restructuring of public debt represents a default. Nevertheless, in February 1935, the Supreme Court declared the Congress resolution constitutional. Chief Justice Charles Evans Hughes called the resolution immoral but legitimate.

The 1979 Default

Once the United States did default, unintentionally, for a very short time. On May 9, 1979, the Wall Street Journal reported the U.S. Treasury was unable to repay its $122 million obligations in a timely manner due to administrative confusion. Again, by all modern definitions, this was a default, even if it was of a technical nature.

The Treasury paid the face value of the promissory notes, but a class action was filed against the United States in the Federal court of the Central District of California by bondholders claiming additional interest for delays. The government decided to avoid further publicity by satisfying the demands of disgruntled investors. Eventually, it was proposed to consider the debt ceiling automatically raised to the required level, as soon as the budget for the next financial year is approved, the so-called Gephardt rule. Thus far, this is the only case when the U.S. officially declared a default.

The 2013 Default

In 2013, the world economy faced the threat of a U.S. default, when state bodies were shut down for two weeks due to the dispute over the budget. The United States had reached the federal budget borrowing limit of $16.7 trillion. However, a law was agreed upon which allowed the federal government to resume its work and increase the limit of public debt. Thus, the threat of another technical default was solved.

Expenditure items of the U.S. annual budget have exceeded revenues (which leads to the so-called budget deficit) since the late 1960s (since 1970, the surplus of the annual budget of the United States was recorded only 4 times — in 1998-2001). In addition, it often happens that the growth of the deficit and the debt are usually associated with the ruling party and the policies of the U.S. President: Remember, for example, the tax incentives President Bush, the war in Iraq and Afghanistan, the costs of overcoming the crisis consequences of 2007-2009, their maximum values, and the national debt reached during President Obama’s reign. The budget was bursting due to the reform of the health insurance system (the so-called Obamacare or Affordable Care Act). Clinton, on the contrary, during his reign made efforts to eliminate the deficit.

The Gold standard kept the budget from deficit

The most negative impact on the development of the U.S. national debt was the gold standard abolition by President Richard Nixon in 1971 — an event called "Nixon shock." Up to this, it was possible to exchange dollars for gold.

In 1966, the U.S. held about $13.2 billion in gold reserve. Despite that this was enough to support the dollar within the country, these volumes were not enough to cover the amounts abroad. The cost of the Vietnam War and the concurrent gold standard abolition led to the first significant cost overruns by Congress.

The History of U.S. Defaults

The blue dotted line marks the year when the United States abandoned the gold standard forever. Despite that prior to these documented cases of budget deficit, after the removal of the standard, the scale and pace of growth of the deficit have increased significantly. With the exception of four years during Clinton's second term, virtually every year since the gold standard abolition in the country is characterized by a budget deficit.

Causes without consequences

Default is considered to be the main reason for default but this is not an exact definition. Default can be caused by many things. In this regard, of particular interest is the constant growth of the U.S. budget deficit, the closure of which is due to the issue of public debt. The U.S. national debt is denominated in dollars, and if necessary, the Fed has the ability to print a new money supply to buy out debt. No other country in the world has such an opportunity. There are objective reasons for overspending the country's budget. For example, during a serious economic crisis, the government may need to intervene and provide assistance to the victims. In addition, during a war, epidemic or natural disaster, the task is to maintain the standard of living and protect the interests of the population and the country as a whole.

The History of U.S. Defaults

The ratio of the U.S. national debt to GDP peaked in 1946 as a result of massive military spending during the Second World War. That time this figure was 121.2% of GDP but the faster economic growth over the growth of public debt (from the mid-1940s to the early 1980s) allowed to reduce this figure to the level of 33-36%. At the same time, since Ronald Reagan’s first presidential term, the U.S. national debt continues to increase steadily, while maintaining the threat of default.

In response to a permanent increase in debt, in 1985 the Congress adopted the act on balanced budget and deficit control in emergencies (Gramm–Rudman–Hollings Balanced Budget and Emergency Deficit Control Act of 1985 and the Balanced Budget and Emergency Deficit Control Reaffirmation Act of 1987 , together often known as Gramm–Rudman). The act provided for annual measures to reduce the deficit and achieve a balanced budget by 1991 (later this period was extended several times).

Thus, to date, a U.S. default can occur only if Congress prohibits the Federal government from raising the limit of public debt.

Author: USA Really