On Debt Repudiation

The US Debt, a national blessing in the words of Alexander Hamilton, continues to rise in size despite an economy as strong as its going to get. Over recent decades it has risen as a share of gross domestic product.US-Debt-GDP-Ratio



We can discuss causes: decline in revenue due to recession and tax cuts; increased spending due to interest on the debt (which is a positive feedback system), economic stimulus during recessions, and defense spending. While it is not at the World War II record high, it’s higher than its been in the post-war period. While interest rates have been low for the past few decades (especially the last decade), there is no guarantee this will continue. And when interest rates rise, the debt will be more and more difficult to repay.

Who owns the debt? The $21T debt ($65,000 per capita) is owned both by Americans and by foreigners. About 28% of the debt is owed to the government itself (think about the Social Security Trust Fund). Of the remainder ($14.8T) half is owned by foreigners. China owns a bit over $1T. That’s a lot of money of course. The interest on that at 2% per year is $20B/year (you can do the math at different interest rates). So far, that’s hardly enough to break the economy over, though you can easily imagine an unwise President doing so.

In olden days, a superpower could send troops into a foreign country to seize assets when debts were unpaid, such as the US invasion of The Dominican Republic in the early 20th century.  Instead today it is the most powerful that is becoming increasingly financially strapped.

An historic example is England’s King Edward I whose populace was in debt to Jewish money-lenders (since Jews were not bound by Catholic prohibitions on usury but were prohibited from other activities), choose to issue the Edict of Expulsion in 1290. Only after the Monarchy was deposed by Oliver Cromwell were Jews readmitted to England in 1657.

Imagine it’s 2030 and there is a financial crisis of some form. Interest rates rise because confidence in repayment collapses. The economy locks up. The US is no longer the world’s most trustworthy economy. However, the US still has the strongest military. The US can choose to issue still more debt at ever higher interest rates, or it can turn the table over and no longer play the game. What might a populist President and Congress do?

So instead of the debt-holders being compensated, they are repudiated. The US stops paying interest on all bonds, or selected bonds, or bonds held by selected parties (non US nationals, Chinese) under some trumped up excuse.

Obviously the US can no longer borrow internationally in these circumstances, or even domestically, not for many decades until financiers forgive and forget. But if the interest on the debt is sufficient, this may be a trade-off worth making. Should the US continue to pay, say, $100B annually to its lenders, and borrow more, and get deeper in debt, or just keep the $100B and live within its means going forward.

The US in 2030 is not likely to be the Dominican Republic of 1916, foreign powers cannot simply invade to collect their debt. At best they can declare a trade war and impose tariffs.

I obviously don’t know if something like this plays out, but I do know the market is undervaluing the possibility.