海角大神

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

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

There鈥檚 just one teensy problem: it isn鈥檛 exactly true. The United States defaulted on some Treasury bills in 1979 (ht:聽Jason Zweig). And it paid a steep price for stiffing bondholders.

Terry Zivney and Richard Marcus describe the default in聽The Financial Review聽(sorry, I can鈥檛 find an ungated version):

The United States thus defaulted because Treasury鈥檚 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.

T-bill rates spiked upwards four times in the months around the default. In November 1978, Henry 鈥淒r. Doom鈥� 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 鈥淪aturday night special鈥�).

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鈥檚 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鈥檚 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鈥檚 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鈥檛 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聽this blog post聽by Catherine Rampell and the associated comments.

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