How Do Government Defaults Work?

Stream Research May 17 4 min read

United States treasuries are sold at auction, meaning that the rates on U.S. debt are determined by supply and demand. Treasuries have durations ranging from one month to 30 years, and the yield on U.S. debt is arguably the most important single number on the planet in that it impacts the price of almost everything in the world. Essentially, the history of the U.S. could be told from the perspective of this interest rate chart, with something unique occurring right before our eyes.

The three-month (90 days) and one-month (30 days) T-Bill spread is the largest in U.S. history as U.S. investors are piling into ultra-short term treasury bills (30 days) to avoid getting caught in a potential U.S. Debt Ceiling default. The spread between these rates offered by these two identical periods (30 vs. 90 days) has grown to 171 basis points, meaning that someone willing to wait an additional 60 days would be compensated an extra 1.71%. This is a large margin for what is arguably the safest asset in the world, showing investors’ growing fears of a potential U.S. default.

Numismatics is the study or collection of currency, including coins, tokens, paper money, or other related objects. It is also a study of physical trinkets, broken promises, and governments that have defaulted on their debts, including almost every government that has existed throughout recorded human history. This paper explores the five principal methods governments have used to default on their creditors and the ramifications for their citizens.

1. Argentine Style Default – Do Not Pay, Do Not Negotiate 

Government defaults fall along a spectrum, the most confrontational being the Argentine style default, which is a violent and sudden repudiation of all debts leaving foreign debt holders with little recourse.

The consequences of such a complete government default are typically:

2. Greek Style Default – A little later, a little less, or both 

A default occurs if lenders are paid back one day late or one dollar less than the stipulated amount, but debts can be “restructured” to alter these arrangements. In default, situations are fluid, and debts are negotiable. Lenders can take what is colloquially known as a “haircut,” which must be repaid. In 2015, Greece failed to pay $1.8 billion to the International Monetary Fund after several rounds of additional borrowing (“bailouts”) to pay off existing debts. There were growing concerns over a Greek exit from the Eurozone (potentially leading to an Argentine Style Default), but ultimately debt was extended for ten years, and non-Greek European banks wrote down their debt by 50%. Greek European banks required significant state aid to remain solvent.

Consequences include:

3. Chinese Style Default – Devaluation 

Not all defaults require creditors’ approval, a government can allow or force the value of its currency to fall against other currencies in a process called devaluation. A weak currency can spur exports, decrease imports, and reduce sovereign debt burdens. Devaluation may or may not be in the nation’s control as developed countries (the U.S., European Union, the U.K., etc.) are considered safe havens and would have difficulty devaluing their currencies.

China devalued its currency in 2015 to boost output and again in 2019 in response to tariffs which led to the U.S. Treasury Department officially naming China as a currency manipulator.

Effects of devaluation include:

4. U.K. & French Style Default – Austerity & Pension Reforms 

States can default on their citizens by breaking political promises by changing social services’ terms (a haircut). This is called austerity, and is not very popular. It reduces public sector debt burdens and postpones defaults to external and internal creditors. Austerity measures are often a component of debt restructuring (haircuts) that demonstrates the willingness of a creditor to pay its debts by raising revenue through increased taxation and decreased spending by cutting social services. The U.K. has been operating under austerity measures from 2010 – 2019 and again from 2021 to the present. Despite fierce protests, France has been enacting its “debt stability programme for 2023 – 2027,” which includes raising the state pension age from 62 to 64.

Austerity effects include:

5. Everyone, Everywhere, All at Once Style Default – Inflation 

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily, and while the process impoverishes many, it enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.”

The Economic Consequences of the Peace by John Maynard Keynes

Inflation effects include:


The odds of the United States defaulting directly on its debts (Argentine / Greece) are roughly 2%, as indicated by the credit default swaps to insure against that possibility (as of 4/24/2023). The odds of a Chinese-style default (currency devaluation) are about zero, as the U.S. is the world’s reserve currency. That leaves austerity and inflation as unofficial means upon which the U.S. could default.

Rising interest rates also increase the debt burden of U.S. taxpayers, and you can only postpone a debt problem by issuing more debt; you cannot solve it. When the government promises more than it can provide, its power to tax its citizens comes at a cost, often including decreased political stability and an alteration of the existing social contract.

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