Actually, the United States Has Defaulted

By :: October 4th, 2013

Since the day of Alexander Hamilton, the United States has never defaulted on the federal debt.

That’s what we budget-watchers always say. It’s a great talking point. One that helps bolster the argument that default should not be an option in Washington’s latest debt limit showdown.

There’s just one teensy problem: it isn’t exactly true. The United States defaulted on some Treasury bills in 1979 (ht: Jason Zweig). And it paid a steep price for stiffing bondholders.

Terry Zivney and Richard Marcus describe the default in The Financial Review (sorry, I can’t find an ungated version):

Investors in T-bills maturing April 26, 1979 were told that the U.S. Treasury could not make its payments on maturing securities to individual investors. The Treasury was also late in redeeming T-bills which become due on May 3 and May 10, 1979. The Treasury blamed this delay on an unprecedented volume of participation by small investors, on failure of Congress to act in a timely fashion on the debt ceiling legislation in April, and on an unanticipated failure of word processing equipment used to prepare check schedules.

The United States thus defaulted because Treasury’s back office was on the fritz in the wake of a debt limit showdown.

This default was temporary. Treasury did pay these T-bills after a short delay. But it balked at paying additional interest to cover the period of delay. According to Zivney and Marcus, it required both legal arm twisting and new legislation before Treasury made all investors whole for that additional interest.

The United States thus did default once. It was small. It was unintentional. But it was indeed a default.

And the nation still stands. But that hardly means we should run the experiment again and at larger scale. Zivney and Marcus examined what happened to T-bill interest rates as a result of this small, temporary default. They find a surprisingly large effect. As best they can tell, T-bill interest rates increased about 60 basis points after the first default and remained elevated for at least several months thereafter. A simple way to see that is to look at daily changes in T-bill yields:

1979-treasury-default

T-bill rates spiked upwards four times in the months around the default. In November 1978, Henry “Dr. Doom” Kaufman predicted that interest rates would rise. They did. Turn-of-the-year cash management disrupted rates as 1978 became 1979. And rates spiked and fell in October 1979 when Paul Volcker announced that the Fed would target monetary aggregates rather than interest rates (the “Saturday night special”).

The fourth big move was the day of the first default, when T-bill rates rose almost 0.6 percentage points (i.e., 60 basis points).There’s no indication this increase reversed in the days that followed (the vertical line on the chart is just a marker for the day of default). Indeed, using more sophisticated means, including comparing T-bill rates to interest on commercial paper, the authors conclude that default led to a persistent increase in T-bill rates and, therefore, higher borrowing costs for the federal government.

The financial world has changed dramatically in the intervening decades. T-bill rates hover near zero compared to the 9-10 percent range of the late 1970s; that means a temporary delay in payments would be less costly for creditors. Treasury’s IT systems are, one hopes, more reliable that 1970s vintage word processors. And one should take care not to make too much of a single data point.

But it’s the only data point we have on a U.S. default. Not surprisingly it shows that even small, temporary default is a bad idea. Our leaders shouldn’t come close to risking it.

P.S. Some observers believe the United States also defaulted in 1933 when it abrogated the gold clause. The United States made its payments on time in dollars, but eliminated the option to take payment in gold. For a quick overview of this and related issues, see this blog post by Catherine Rampell and the associated comments.

P.P.S. This post originally appeared in May 2011. This version has been slightly edited.

44Comments

  1. foosion  ::  9:02 am on October 4th, 2013:

    Consider how much worse an intentional default would be than a processing issue.

  2. David Lloyd-Jones  ::  9:27 am on October 4th, 2013:

    There’s an 1824, I think it is, Committee in London which meets for a couple of bottles of port every time Mississippi issues a bond. Apparently they defaulted on something a couple of hundred years ago — and they’re still paying the premium for it.

    On the violation of the gold clause in 1933 note one ugly little fact: it was a price support. As with milk, the Treasury was buying up gold above the market price and pouring it down a hole to keep it off the market.

    Only eccentric legalists objected.

    -dlj.

  3. Tax Roundup, 10/4/2013: Anniversary. And… the Chromaro! « Roth & Company, P.C  ::  9:30 am on October 4th, 2013:

    […] Marron, Actually, the United States Has Defaulted (TaxVox): “The United States defaulted on some Treasury bills in 1979 (ht: Jason Zweig). And […]

  4. Dave Peterson  ::  10:13 am on October 4th, 2013:

    The US government was in chronic default of its obligations in the period during and immediately following the Revolutionary War. They had to sell the Western territories in order to pay off the national debt.

  5. Victor Wooten  ::  2:47 pm on October 4th, 2013:

    The great Breakthrough in your life comes when you realize it that you can learn anything you need to learn to accomplish any goal that you set for yourself.This means there are no limits on what you can be, have or do.

  6. Michael Bindner  ::  11:19 pm on October 4th, 2013:

    Some might say that a bit of a raise in interest rates would be a good thing and we are not likely to follow a default with a Fed Chair out to control inflation by raising interest rates (appointing Volker was the stupidest political decision Carter ever made). The problem is that today the world economy is even more invested in dollars and American debt than it was in 1979. What was a blip then may be ruin now, especially where the cost of imported goods is concerned. That kills a VAT for now, but it may be good for American industry.

  7. David Lloyd-Jones  ::  12:00 am on October 5th, 2013:

    Michael,

    You write “The problem is that today the world economy is even more invested in dollars and American debt than it was in 1979.”

    I wonder if this is true? Why do you say so, and what is your sense of “being invested in”?

    There are certainly more US Treasury Bills of all terms from days to decades all around the planet than there were in 1979. On the other hand the Euro and gold have both gone through price changes huge enough to suggest a lot of warehousing going on.

    What you call a “blip” back then is interesting. I was in my office in the Rayburn Building at 4.00 a.m. on August 15th, and a friend from the office across the hall had recently gone done the Hill to Treasury. He knew my working hours, all 24, so I was one of the first to get a phone call telling me that the US was going off gold. Bill Buckley, my old neighbour from New York went out and bought an ounce, and announced in National Review that it had doubled in value a very few months later. Some blip.

    Under Nixon the dollar went from the 360 yen at which it had been pegged, at least in Pacific trade, for a generation to 300 or so floating, overnight. Mistresses were, uh, laid off by Counsellors in the Tokyo Embassy. Overnight or not, I am not informed. You are quite right about the trade effects: I was to spend the next ten years building coin laundries all over Japan — using dryers built in Texas. Japanese laundry has probably built a couple of villages in Mexico in the time since.

    I am a fount of funny stories about currencies simply because trade was my living for so long. However I have no biases but the traders’. And I don’t know the answers to the questions I’m asking you, so I really would like any pointers you can give me.

    Is the world more or less “on the dollar” today than it was in 1979?

    Best wishes,

    -dlj.

  8. John C. Randolph  ::  10:57 pm on October 5th, 2013:

    I would argue that US dollars are notes in default, and have been at least since FDR stole all the gold in the country.

    -jcr

  9. David Lloyd-Jones  ::  11:11 pm on October 5th, 2013:

    John,

    you ignorant slut, as I have pointed out elsewhere on this page, FDR didn’t steal anything: he bought all the gold in the country at well above the market price.

    He did the same thing with milk, and then he poured both of them down holes in the ground, to take them off the market and support the market.

    The gold mine owners were just as happy as the dairy farmers: FDR had just put them back in business.

    American style socialism: the government bails out the property owners. For unto them that hath shall be given. Matthew 4:25.

    -dlj.

  10. David Lloyd-Jones  ::  11:18 pm on October 5th, 2013:

    Victor,

    The slogan of Wall Street. Self-improvement every moment.

    “…there are no limits on what you can be, have or do.”

    Least of all the law, or any honest auditors or ratings agencies.

    -dlj.

  11. David Lloyd-Jones  ::  11:26 pm on October 5th, 2013:

    Dave,

    The first half of this is true. The second you’re simply making up out of thin air, which is the way things are commonly done in tax and investment discussions, I know.

    The fact is Hamilton imported the notion of “national debt,” which the English had invented somewhat earlier under David Ricardo’s tutelage. (The French never managed to get the idea quite right, which is why they went to the guillotine…) Once he had the notion straight he then went and borrowed all the money he needed from a man named Albert Gallatin, whose credit was better than that of either the old confederated United States or the new constitutional United States of America.

    The Western Territories were for the most part given away free, which is why railroads were such fun, and why there are to this day socialists in Wisconsin and Minnesota. Oklahomans were almost alone in having to pay for their land: the Sooners are the people who got there sooner, and got the good land by the creeks and rivers.

    But don’t let me stop you from practicing.

    -dlj.

  12. David Lloyd-Jones  ::  11:33 pm on October 5th, 2013:

    Foosion,

    Don’t worry, the Red States won’t have to pay for it: it will all come out of the taxpayers, and all the net net taxpayers are in the Blue states.

    In Old Greenwich, Connecticut, Julio J. Castro will lose his job polishing J. Horton Campbell III’s yachts, because poor J. Horton will be squeezing his nickels until his next TARP cheques come through from Washington.

    -dlj.

    -dlj.

  13. LLC TAX FREE STATES 2014  ::  7:30 pm on October 6th, 2013:

    […] Actually, the United States Has Defaulted – TaxVox – Tax Policy Center […]

  14. Mr. Econotarian  ::  7:35 pm on October 6th, 2013:

    Congress pass the Gold Clause Ban in 1933, which retroactively invalidated any “payable in gold” clauses in any private contracts. It was the only way to devalue the dollar vs. gold without putting every borrower way underwater.

  15. David Lloyd-Jones  ::  9:12 pm on October 6th, 2013:

    Anonymous Eco,

    The gold clause ban simply said that it was as silly to make gold a negotiable as it was to enshrine milk, or any other thing, as a currency. If you’re happy that it was not an inflation, bully for you.

    It recognized the sound principle that the thing to use as money is money.

    -dlj.

  16. 2014 TAX FREE STATES SHOPPING  ::  10:19 pm on October 6th, 2013:

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  17. ONLINE TAX FREE STATES 2014  ::  11:37 pm on October 6th, 2013:

    […] Actually, the United States Has Defaulted – TaxVox – Tax Policy Center […]

  18. TAX FREE WEEKEND UNITED STATES 2014  ::  1:55 am on October 7th, 2013:

    […] Actually, the United States Has Defaulted – TaxVox – Tax Policy Center […]

  19. Secondary Sources: Why No Taper?, U.S. Default, Returning to Egypt – Real Time Economics – WSJ  ::  1:49 pm on October 7th, 2013:

    […] –U.S. Default: Donald Marron notes that the U.S. has defaulted. “The United States thus defaulted because Treasury’s back office was on the fritz in the wake of a debt limit showdown. This default was temporary. Treasury did pay these T-bills after a short delay. But it balked at paying additional interest to cover the period of delay. According to Zivney and Marcus, it required both legal arm twisting and new legislation before Treasury made all investors whole for that additional interest. The United States thus did default once. It was small. It was unintentional. But it was indeed a default. And the nation still stands. But that hardly means we should run the experiment again and at larger scale. Zivney and Marcus examined what happened to T-bill interest rates as a result of this small, temporary default. They find a surprisingly large effect. As best they can tell, T-bill interest rates increased about 60 basis points after the first default and remained elevated for at least several months thereafter. A simple way to see that is to look at daily changes in T-bill yields” […]

  20. Michael Bindner  ::  1:58 pm on October 7th, 2013:

    What is different now is that our dollars are backing their currencies.

  21. David Lloyd-Jones  ::  2:50 pm on October 7th, 2013:

    John,

    I understand that that is what you said. There is no need to repeat yourself.

    My question was, why do you say that?

    -dlj.

  22. David Lloyd-Jones  ::  2:51 pm on October 7th, 2013:

    Sorry, not “John,” Michael above.

    Apologies.

    -dlj.

  23. Bad Sign: Investors Comparing US Treasury To Brazil – Forbes | Top Breaking News  ::  4:57 am on October 9th, 2013:

    […] my Tax Policy Center colleague Donald Marron notes, in 1979 the U.S. did briefly miss payments on Treasury bills—an inadvertent default caused by a […]

  24. It is never good when the U.S. Treasury gets compared to Brazil | TokNok Multi Social Blogging Solutions  ::  10:08 am on October 9th, 2013:

    […] my colleague Donald Marron notes, in 1979 the U.S. did briefly miss payments on Treasury bills—an inadvertent default caused by a […]

  25. “I Say It’s Default, and I Say the Hell With It.” | Back in the Black  ::  2:27 pm on October 11th, 2013:

    […] (or should) accept – would be to allow what they would perceive to be the first default (see this  for a technicality) by the United States of America.  Accordingly my money – whether in cash […]

  26. What Happens If Congress Can’t Make A Deal On The Debt? | EikAwaz  ::  3:36 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  27. What Happens If Congress Can’t Make A Deal On The Debt? | TokNok Multi Social Blogging Solutions  ::  3:40 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  28. What Happens If Congress Can't Make A Deal On The Debt? – Owaisi Brothers | Owaisi Brothers  ::  4:11 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  29. KMBH 88FM | What Happens If Congress Can’t Make A Deal On The Debt?  ::  4:29 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  30. What Happens If Congress Can’t Make A Deal On The Debt? | The First Farm Site  ::  5:21 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  31. John C. Randolph  ::  9:05 pm on October 15th, 2013:

    “you ignorant slut”

    I’m not your mother, David.

    When you take someone’s gold and give them paper scrip that’s not redeemable for anything, that’s theft.

    -jcr

  32. David Lloyd-Jones  ::  9:15 pm on October 15th, 2013:

    Funny,

    Paper is what every gold miner in the world was trying to get for the almost useless metal they were diggin up.

    FDR paid them above the market price just to make ’em happy, and most of them were.

    The whiners were not for the most part gold miners. They were the usual professional producers of false martrydom and self-pity: the right-wing political ideologues.

    Don’t cry for them: they usually end up well paid as Republican politicians and then as lobbyists.

    -dlj.

  33. What Happens If Congress Can’t Make A Deal On The Debt? | loneeaef173  ::  9:31 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  34. What Happens If Congress Can’t Make A Deal On The Debt? | irvingtnw599  ::  9:32 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  35. What Happens If Congress Can’t Make A Deal On The Debt? « hobiegww775  ::  9:52 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  36. What Happens If Congress Can’t Make A Deal On The Debt? | olgahkb478  ::  9:56 pm on October 15th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  37. What Happens If Congress Can’t Make A Deal On The Debt? | taberyos467  ::  3:55 am on October 16th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  38. What Happens If Congress Can’t Make A Deal On The Debt? | cucinudob  ::  4:26 pm on October 16th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  39. What Happens If Congress Can’t Make A Deal On The Debt? | nicollexfh123  ::  3:59 am on October 19th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  40. What Happens If Congress Can’t Make A Deal On The Debt? | isovolale  ::  9:38 am on October 20th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  41. What Happens If Congress Can’t Make A Deal On The Debt? | gussnsf132  ::  9:59 am on October 20th, 2013:

    […] Back in 1979, there was an almost inadvertent bond default that had to do with Treasury’s back-office functions not being able to get up to speed in time following another game of debt-ceiling chicken. Even failing to pay off a fairly small amount of bonds for a brief period of time significantly raised the amount of interest Treasury had to pay creditors for some months. […]

  42. The U.S.May Not Default on Friday But Washington Is Still Playing A Dangerous Game | electronics-trade Products articles blog  ::  4:55 am on December 21st, 2013:

    […] us in largely unchartered waters, though my Tax Policy Center colleague Donald Marron noted in a recent blog post that an accidental short-term default in 1979 caused a sharp spike in interest […]

  43. Happy Hour: Shutdown And Your Money • Novel Investor  ::  12:56 pm on January 7th, 2014:

    […] Actually, the United States Has Defaulted – a small-scale version of what would happen if the U.S. defaulted. […]

  44. Financial News Friday – October 4, 2013 | Realize Your Retirement Testing Site  ::  2:04 pm on July 19th, 2014:

    […] The US government has defaulted on its loans once before.  In the scheme of things it’s a small blip, a couple of weeks of time during 1979, but it had large ramifications for the interest rate. After the small default due to technology issues and fights over the raising of the debt ceiling, the Treasury could not pay many individual investors the par value of their bonds at maturity. Over the weeks after the default Treasury interest rates on T-bills increased by around 0.6%. (TaxVox) […]