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HISTORY: The Day the United States Defaulted on Treasury Bills
Tax Policy Center ^ | 05/31/2011 | Donald Marron

Posted on 05/31/2011 7:45:44 AM PDT by SeekAndFind

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 ongoing debt limit slowdown.

There’s just one teensy problem: it isn’t true. As Jason Zweig of the Wall Street Journal recently noted, the United States defaulted on some Treasury bills in 1979. 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.

This default was, of course, 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.

Some may quibble about whether this constitutes default. After all, the United States did eventually make its payments. And the disruption applied to only a sliver of its debt – certain T-bills owned by individual investors.

But I think it’s unambiguous. A debt default occurs anytime a creditor fails to make a timely interest or principal payment. By that standard, the United States did default. 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:

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 caused rates to fall and then rise 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 temporary default is a bad idea.

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 at the New York Times and the associated comments.

TOPICS: Business/Economy; Culture/Society; Government; News/Current Events
KEYWORDS: debt; default; treasury; usa

1 posted on 05/31/2011 7:45:47 AM PDT by SeekAndFind
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To: SeekAndFind

A default would be a mess, but as real spending cuts will likely never happen, I support a default - at least while the USA still has not completely destroyed the notion of States Rights and local Gov’t is not completely yet dependent on the Feds. There are still folks around who can pick up the pieces.

2 posted on 05/31/2011 8:20:01 AM PDT by PGR88 (I'm so open-minded my brains fell out)
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To: PGR88

real spending cuts will likely never happen,

Repeat LOUD and OFTEN.................

3 posted on 05/31/2011 8:24:25 AM PDT by PeterPrinciple ( getting closer to the truth.................)
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To: PGR88; PeterPrinciple
My prediction: no spending cuts and no default.

Instead, the fed’s will just print the money needed to cover the debt.

End result: massive inflation.

But don't worry. Congress will still be able to fund their stupid and wasteful pet projects. And I'm sure they will adjust their salaries and pensions upward to account for the inflation.

As for the rest of us, better hope McDonalds is hiring.

4 posted on 05/31/2011 8:35:34 AM PDT by Leaning Right (Why am I carrying this lantern, you ask. I am looking for the next Reagan.)
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To: Leaning Right

Very Interesting: The only known time of default was during the Carter Administration.

It seems only fitting that the second default in our history should happen with Carter’s second term of the Obama-nation!

5 posted on 05/31/2011 8:39:00 AM PDT by CoastWatcher
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To: SeekAndFind

And then every holder of T Bills on Planet Earth decided never again to support American debt, and the country’s economy plunged into a Third World status that limped along for decades, during which China and Russia seized world markets and World Islam launched global jihad, leading to World War III - a war America was in no position to win, or even contest.

Probably won’t happen. We hope.

6 posted on 05/31/2011 8:47:10 AM PDT by Jack Hammer
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To: Leaning Right

As for the rest of us, better hope McDonaldsMcDonald’sMacDonald’sMcDonaldMacDonald is hiring.

Who will be eating at McDonaldsMcDonald’sMacDonald’sMcDonaldMacDonald?

My observation is tough decisions are seldom made early. I don’t know how this plays out. In working with farmers in the 80’sS’sW’sY’sA’sB’sC’sD’sE’sF’sG’sH’sJ’sK’sL’sM’sN’sP’sQ’sR’sT’sV’sX’sSsSSAsBSCsEsHSKSKsMSMsNSOSOsPSUSXSZsascsesgsiskslsms, there were no problems until the cash stopped. When the bank stopped lending, it became a problem and of course it was the banks fault. The banks forced them into bankruptcy.

When will the cash stop for the US. Tell me what it will look like. Nothing will change until the cash stops.

7 posted on 05/31/2011 8:52:07 AM PDT by PeterPrinciple ( getting closer to the truth.................)
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To: SeekAndFind

“unanticipated failure of word processing equipment used to prepare check schedules”

They blamed it on faulty typewriters? OH COME ON!!!
That Jimmy Carter administration was utterly pathetic!

Wonder what my sophomore year American History prof would have said if I failed to turn in my thesis due to “unanticipated failure of word processing equipment”.

8 posted on 05/31/2011 9:03:40 AM PDT by Buckeye McFrog
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To: SeekAndFind

What happens when China won’t lend us enough money to defend ourselves against them?

9 posted on 05/31/2011 9:09:13 AM PDT by Dixie Yooper (Ephesians 6:11)
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