Debt Ceilings Aren’t The Only Way America Can Default

Posted by Jeff Rubin on July 20th, 2011 under SmallerWorld • 32 Comments

For the People’s Bank of China, which is long a trillion or so dollars of U.S. Treasury bonds, it is impossible not to notice the game of debt brinkmanship currently being played in Washington.

If Congress does the unthinkable by not raising the debt ceiling, the U.S. government will start defaulting on its debt, of which the People’s Bank of China is the single largest holder.

There, of course, have been other debt ceiling impasses on Capital Hill in the past, and there will undoubtedly be more in the future. The Chinese can rest assured that the current budget impasse, like the others before, will not be allowed to trigger a default.

At the same time, the Chinese know there is more than one way for America to  default, especially for a borrower such as the U.S. whose debt is conveniently funded in its  own currency.

The U.S. Treasury has never defaulted in the classic sense of not paying its bondholders on time but that doesn’t mean it hasn’t short changed its foreign creditors before. Just ask Japanese insurance companies that loaded up on Treasury bonds during the 1970s, seeking the higher yields they were offering over the JGB (Japanese Government Bond).

The U.S. Treasury never missed a coupon payment and all the bonds were paid out 100 cents on the dollar. Only the U.S. dollar didn’t buy the same number of yen when those insurance companies cashed in their maturing 10-year Treasury bonds than it did when they bought them.

Between 1971 and 1981 , the U.S. dollar lost 40% of its value against the yen, leaving the Japanese insurance companies with a huge foreign exchange loss on their U.S. bond portfolios.  In retrospect, those yield-hungry institutions would have been better off if they had invested in lower interest bearing JGBs.

Given the size of the trade imbalance between China and the U.S., it is not difficult to imagine an even larger depreciation of the greenback against the Yuan over the next decade. Indeed, the greenback could easily lose half its value against the Yuan over the course of a 10-year Treasury bond.

One way or another, Congress will call off its game of chicken with the Obama administration by raising the debt ceiling before the August 2 deadline. But that doesn’t mean the U.S. won’t be defaulting on its Chinese creditors down the road, just as it did on its Japanese  creditors in the 1970s.


  • JB

    Japan did not have much choice…

    It is however doubtful that China will simply accept a massive “masked” default of the US on its financial obligations?

    Are we withnessing the prelude of WWIII ?

  • GTI

    WW3?The Chinese are not stupid enough to start a war andThe US has to borrow the money from China to attack it!all the Chinese have to do to stop a US attack is sell all their US dollar/treasuries and the US dollar collapses. The Chinese military calls it their “2nd nuclear option”. The US military is the largest user of oil in the world, they cannot attack without oil. If the dollar collapses they can’t buy oil, and will get kicked out of all their bases worldwide when they can’t pay rent. It is the fate of all empires, just a matter of time. The US dollar has more power than the US military. They could not beat Korea, they lost in Vietnam and I doubt history will call either Iraq or Afganistan a victory. Logistics determines victory, something the founding fathers knew, but the lesson has been long lost. They are a paper tiger, dangerous to many people, but their true power is too diminished to attack China. And they will not cure their economic problems until they stop spending half their money on the military.   

  • JDO

    A few corrections: The U.S. could miss the debt ceiling deadline and still make payments on its debt from the cash flow coming in. It would force drastic cuts in spending elsewhere, but the debt could still be serviced from the $200b or so cash flow each month (and debt payments are somewhere in the $20b a month range).

    And, the U.S. HAS defaulted in the past .. twice. In the early days of the union, the Federal government took on the obligations of the colonial states that came into the union, but deferred interest payments for 10 years — a clear default. And when FDR outlawed gold and revalued the dollar, that was a default in a different sense. U.S. debt at the time allowed for bonds to be repaid in cash or gold based on the value of gold at the time the bonds were issued. By devaluing the dollar vis-a-vis gold, FDR effectively defaulted on America’s debt. 

  • Johan Wilson

    but isen’t the yan pegged to the dollar?

  • Anonymous

    Yes, exactly. What is missing, however, is a comparison to how much the U.S. (not just the government, but consumers also) has defaulted on the American farmers and small towns in the same way they defaulted on the Japanese insurance companies.
    You want to ‘create’ jobs? Pay what you owe your grandparents and their neighbors who are now living in poverty while corporations drive Transformer-sized (the movie, not the toys) robots spewing poisons on the land which gives you life.
    Food should be 40% of your income. That money everyone spent on gold faucets and iPads and Hummvees? That was enabled by cheap food, not “economic expansion”.
    The wealth that has accumulated in the top 2% and in offshore banks? That is all of those ghost towns and general stores turned ‘antique’ shops selling the tools your grandparents used to use to feed your parents and send them to school and auto factories with the skills to build the ‘economy’ everyone is now mourning.

  • Rojelio

    Inflate the debt away baby! There’s no other way out other than ending the central banking system, but it doesn’t seem like that’s even open for discussion.

    What keeps China coming back to the bond auctions? Are they simply trying to prevent a monetary nuclear meltdown by purchasing more treasuries?

  • Rojelio

    What are you suggesting, that perhaps China will try to take over the role of military police in the middle east?

  • Just Tired

    What choice did China have? For that matter, what choice did Germany have when they exported all that good German stuff for PIGGs IOUs?  Why is it that economists are always decrying the fact that countries with big trade surpluses ending up with worthless paper at the end of the day.  When you sell tangible goods to people who can’t pay for them, there is no financial engineering that can turn worthless paper into gold.  That has been tried since the beginning of time.  China certainly can remember the lesson of how trade went with the British leading up to when Hong Kong was taken.  Why do they think this time there will be a more suitable outcome?  Stupid is as stupid does.

  • Russ Wetherill

    First of all, China is the single largest FOREIGN owner of the the US debt at 7.5% of total debt. The Social Security, Military, and Civil Service trust funds hold more than 60% of the debt. If we default equally on all debts, we will feel the lion’s share of the pain, not foreign investors. If we default disproportionately on foreign holders, we risk a trade war (see The Great Depression for how that worked out).

    Second, foreign currency risk is always a factor when buying foreign bonds. This only becomes an issue when a foreign government tries to sell those bonds and repatriate the proceeds. I doubt that given the high inflation in China right now, that China will want to repatriate those assets and pour more gas on their economic growth.

    Also, what makes you think that China, a notorious currency manipulator, will allow the dollar to depreciate against the yuan? China’s entire economic model is based on keeping the dollar high relative to their currency to make their exports competitive vis-a-vis our own. And, isn’t China the one seeing wide-scale inflation right now? If not for control the yuan, wouldn’t the yuan be rising dramatically vs the dollar right now?

    Let’s be clear, a default on the debt means that when interest is due, it isn’t paid. That doesn’t mean that the principal disappears, or that the debt obligation is defunct. It only means that creditors don’t get their payment this quarter. This will no doubt drive up borrowing costs, but, with any insolvent debtor, a payment plan can be worked out.

  • Anonymous


    Seriously, the bigger issue here is the simple fact that the USA can no longer honor its past obligations without taking on debt.  Some have said that the US could honor its debts but at terrible cost to our social programs (they would never cut military spending). 

    At some point the rest of the world, especially OPEC, may decide that they do not want worthless dollars but something more tangible.  That, and that alone, will be the day that the American Empire ceases to exist. 

    That day may be just around the corner.

  • Nobel1979

     Do you think with so much of US$ holding Chinese would survive. Both the countries US and China will collapse.China will not dare to do such a thing.

  • Nobel1979

     Do you think with so much of US$ holding Chinese would survive. Both the countries US and China will collapse.China will not dare to do such a thing.

  • Pete

    Can’t we just electrify railways and power ships directly with fission reactors?

  • GTI

    if the choice is have the US attack or bankrupt them before they can start? Pretty easy choice, if those are the stakes. And China would survive, their holdings are assets that do not have debt attached. It is different than losing an asset that is mortgaged. They would recover something in a sell off, and they would suffer, but not as devasting as you might think. If the US dollar loses its status as world’s reserve currency, that would be devasting to US (Nickelthrower has it right)

    and they are not the ones making noises, those come from right wing nuts and military types in the US. They are just making the point that they will not be intimidated. Like when their new submarine popped up in the middle of the 7th’s Fleets war games and the US had no clue it was there, slipped past all their sonar. Chinese said it was a mistake, but they were sending a message. The Chinese have no interest in starting wars, but they understand the Anglo propensity for doing so.

  • Instincts

    The U.S. Empire has been falling for the better part of the last decade,
    but the right wing/militarian dominants and their egos within that
    nation refuse to recognize and acknowledge or accept it.

    nations such as the U.S. (and many others) realize and accept that they
    simply must learn to live within their means, and scrap this almost
    globally ubiquitous flawed socio-economic model that assumes infinite
    growth while ignoring the limits and laws that finite resources (real
    life things) imposes, then the U.S. and other nations like PIGS aren’t
    going to be the only ones to fall.

    When are we going to learn
    that this pointless struggle between nations to be the ‘last one
    standing’, from a socio-economic sense, isn’t ultimately going to
    achieve any real gains when the vast remaining world (inclusive of
    humanity/socio-economy AND the natural environment) around them has
    become so degraded that the End can hardly justify the Means?

    this really is about is Earth’s human population, having become so
    unchecked, is well on its way into chaos and eventual crash, events well
    known to occur when any population that outgrows the basic resources
    that are the only thing maintaining that population in the first place!

    Tapping into stored fossil solar-derived energy, as well as some
    dumb-ass idea to try to infinitely create money by infinitely creating
    debt, only cheated us into thinking that we are beyond or immune to the
    basic natural laws and limits of this planet.

    It isn’t a
    coincidence that S@!# is simultaneously hitting the fan globally on the
    energy, monetary, and social order fronts.  These have become so
    intricately interdependent and self-indulged that most people have
    completely forgotten that at the end of the day, all that really matters
    is quality air, basic water & food, basic shelter, and adequate
    space — all of which can bring content exclusive of all the other crap
    that has complicated and clouded what people otherwise view to be

    Ya, there have been wars and much greater social disorder
    in the past.  But the game has changed this time.  This time its not a
    game where we get a second or additional chances — its the real-deal
    and we have one chance to get it right or humanity as we know it is
    toast (though arguably that might be a good thing).

    And it begins with embracing the reality that there simply will have to be fewer, not more, of us on Earth. 

  • Frankpetracek

    Game over it’s just a matter of what domino falls first,Greece,Spain,or the us, it was a good ride while it lasted, I’m in my home near Malibu bought for 300 thousand put 200 into it worth 650 thousand for now, wife lost 250,000 dollar job., utilities are killing us

  • Frankpetracek

    Saw a quarter in half it well shock you they are worth .50 yes one half cent if you melt it down pre 1964 are worth 7.00 dollars scary

  • Frankpetracek

    .05 sorry

  • Frankpetracek

    Make sure that fence along the Mexican border is low enough for a 50 year old to clear, might have to go south for work.

  • Frankpetracek

    The deficit number is beyond anything we could ever pay back, they lower are credit rating more interest payment, I’m 50 and seen enough recessions this is to big to come back from the only jobs were created from housing, a box you had to fill great scam while it lasted, I’m in north of Malibu and it’s a blood bath

  • Instincts

    A lot of people don’t understand or (care to) appreciate the significance of compound interest, nor the real effects that principle has on things, such as interest or growth in terms of real numbers, aside from percentages.

    Consider a mouse that weighs 10 ounces, and a whale that weighs 10 tons or 20,000 pounds. 

    A 50% increase in that mouse’s weight over a one year period is 5 ounces.

    A 5% increase in that whale’s weight over a one year period is 1000 pounds or 16,000 ounces.

    Note the 45% less percent increase in the elephant’s weight than that of the mouse, yet still a 15,995 ounce REAL increase over that of the mouse.   This is why, if a person must choose, shouldn’t be blinded into paying off a $1000 credit card debt that has $15% monthy interest over pre-paying $1000 of pure principle on a $150,000 mortgage, even though it only has $3.5% monthly interest, especially early in the loan period.

    Now consider a debt like that of the U.S., which is in the realm of $14 trillion and rising.
    That’s $14,000,000,000,000

    To eliminate that debt (i.e., wipe out the principle), it would take 1,400 billionaires to simultaneously agree to eacj give the U.S. Treasury $10 billion dollars, just to bring the principle to zero, ignoring the enormous interest constantantly building on that principle.  A 1/2% (0.5%) monthly interest accrual on such a principal equates to $70 billion ($70,000,000,000) per month.  Lacking any ability to pay off any of that $14 billion principle (a likely scenario), it would alternatively require 7 of those billionaires to each kick-in $10 billion each month, just to keep the principle balanced at $14 billion.  Fat chance such a saviour scenerio would ever occur.

    …ya, I’d say its beyond anything that the U.S. could ever pay back, let alone keep from skyrocketing out of control — especially if they keep trying to maintain their ‘king of the hill’ military presence worldwide.

    Frankpetracek, not sure what to say, other than that there are certain EU nations that could teach us (or could have been teaching us) a lot and save(d) us a lot of grief if we would just quit being so godamn self-righteous and allow some of these advanced nations save us a lot of pain and grief.  But it looks like we’re suckers for learning the hard way. 

    The Party is Over in North America for most people, and I’m beginning to feel a bit nervous living so close to the U.S. border.  If it weren’t for the social chaos that goes along with big change, I’m kinda looking forward to my World that’s about to become a Whole Lot Smaller.

  • Abitibidoug

    Excellent posting, couldn’t have said it better. As I said in the topic BP Report Shows EconomicGrowth Still Dependent on Oil a month ago, this idea of endless growth should be seen as a thing of the past. Now is the time for a steady state economy in developed countries like the United States. The problem is that all this money, from borrowing, has been thrown at the economy to try and keep the old idea of endless growth going and to no avail. Now the worst part, how will future generations ever pay it back?

  • Rojelio

    True. I don’t see how we’re going to avoid resource wars at this point. What was the sustainable population before big oil/big coal, a million or so?

  • Rojelio

     I used to live in the UCLA area years ago but I hear California’s becoming a hellhole. Are you sure it’s worth 650 now? There’s not a lot of American’s left that can afford that.

  • Rojelio

    apparently not

  • Rojelio

    Russ, the payment plan is being worked out. You may have noticed the sound of the printing press in the background.

  • Rojelio

    “The U.S. could miss the debt ceiling deadline and still make payments on its debt”

    In theory that is correct, but explain which politicians will be up for gutting all the social programs immediately and putting the military into a figure 4 leg lock starting in September. We’re about as likely to stop spending as we are to stop emitting CO2 at suicidal levels.

  • Instincts

    Jeff – As usual, a well stated column on a key topic of our current times.

    One must wonder if this game of chicken that Congress – Obama Admin. is playing isn’t just a ploy to keep the U.S. dollar value low during the peak oil-use period in the U.S.  As we know, a weakening U.S. dollar generally means weakened oil prices.  But given how global demand is increasingly overshadowing supply in oil, at best all it might only mean keeping a somewhat tighter reign on global oil prices from spiking to $150+/barrel and yet again kill demand and spiral into yet a deeper recession.

    But of course, playing Chicken like this risks puttting the future dominance of the Greenback at great risk if they go overboard, whether intentionally or non-intentionally.  Somehow, one must wonder if there’s more to this U.S. tug-of-war than just politics.

  • Instincts

    Exactly.  What the world needs is a major monetary reform, and leveling out of wealth distribution; one that doesn’t assume that debt can infinitely be created to infinitely create money — because as we are now seeing, the capacity to pay off and service that amount of debt when one gets into orders of magnitude higher (i.e., into the $billions) isn’t a linear function, but rather one that better reflects a logarithmic function. (Recall the Mouse and Elephant example I mentioned previously)

    It is why the rich stay rich and keep getting richer.

    And it is also why whe see interest rates (percentages) able to stay relatively low, yet still yield MAJOR profits to the lenders; the principles are much higher than ever (again, Elephant and Mouse).

    …But of course, all that backfires and implodes when many people within that long list of suckers who took on that debt (at deceivingly low interest rates) are now no longer able to keep up — because at some point, when principles become so high, even the lowest interest rates still equate to REAL dollar values that become impossible to pay and maintain.

    And that list now includes the United States of America’s National Treasury.

  • Instincts

    …I meant $trillions, not $billions.

  • Worried

    The only shortages are caused by political constraints. There is enough oil in the oil sands or the Bakken to run NA for the next 400 years. Not to mention the suddenly available natural gas. As for too many people, this is the same old crap pushed by the Club of Rome which long has been silenced due to eating crow. What is there really to be worried about? Try this:

    Australia is ready to slit its throat following the hari-kari of the European Union. Let not NA be next.

  • Propensity6

    Another great misunderstanding by an econimist that must have failed economics 101. Currencies move to a value that they should be at. We all know that the Chinese have artificially set their currency too low. Therefore, it is logical that it should appreciate against the USD. The only reason the Chinese have so many USD’s is that their currency is artificially low and the US buys a lot of improperly priced goods