The case cited in the article above may be the only time the Treasury has failed to pay interest and principal on its debt. But there are many other ways to default on debt than nonpayment.
Countries can slap on capital controls so investors can’t convert to hard currency or get their money out of a country. Countries can impose 50% withholding taxes, so you can get your money out only after a 50% tax haircut. Countries can resort to inflation so that you get your nominal dollars back, but they’re not worth much in real terms. Countries can force creditors to swap debts that cannot be paid on time as agreed for debt with longer maturities.
Paul Simon had a hit song called “50 Ways to Leave Your Lover.” Sovereign borrowers could collaborate on a new version called “50 Ways to Stiff Your Creditors.” With this expanded definition of default in mind, it’s clear that the U.S. has defaulted on its debts many times.
In the 1950s, the income tax on interest income was 90%. Between 1977 and 1981, the value of the dollar was cut by over 50%. In both cases, parties who had loaned money to the U.S. government years before did not receive anything like what they bargained for in real terms after taxes and inflation.
Perhaps the most egregious example of this kind of designer default was the annulment of contractual “gold clauses” by Congress in 1933, as this article explains. Gold clauses had been around since the U.S. hyperinflation during the Civil War. When a dollar amount was due under a contract, the creditor had the right to demand payment in “gold coin” or “gold equivalent.” This was intended to protect creditors against dollar devaluation and inflation.
The problem was that FDR explicitly wanted to devalue the dollar and create inflation to escape from the deflation of the Great Depression. FDR knew that if gold clauses were enforced, many debtors would default because they would still owe the old debt in “gold equivalent” even though they were paying with newly devalued dollars. So Congress and FDR just made the problem go away by outlawing gold clauses. The court backed up FDR, and creditors got stiffed.
Today gold clauses are once again legal, but I wouldn’t count on Congress or the courts to enforce them in another deflationary scenario. There’s one hedge that’s much better than a gold clause. That’s actual physical gold.
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