“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
~ John Maynard Keynes, The Economic Consequences of the Peace (1919)
Written by Bryan Lutz, Editor at Dollarcollapse.com:
A government default usually looks like this:
- Missed payments,
- Emergency talks,
- And investors dumping bonds.
That’s how Argentina has done it nine times. The government runs out of money… then announces it cannot repay its debts as promised.
The United States is different. Its debt is stored in dollars, and it controls the supply of dollars. So, unless Congress refuses to pay on purpose, the federal government can always create enough currency to meet its obligations.
That makes a formal default unlikely, but it doesn’t make Treasury debt risk-free.
America’s default won’t be the same. It won’t run on the same legalities, and it won’t be covered by the mass media explaining some new glass ceiling. Everything will (and is right now) running on regularly scheduled programming. Like what happened yesterday, bondholders will receive every dollar they were promised.
Except this time, they’ll find that those dollars buy much less.
Default Through Inflation
On August 18, the federal debt passed $40 trillion. On September 8 it stood at $40.08 trillion, which breaks down to about $117,000 for every person in the United States.
Paying that down with budget surpluses would take spending cuts, tax increases or both. Unfortunately, either choice hurts every politician at the ballot box.
Inflation offers another path – a way out for the federal politicians… So they can fulfill their promises and get re-elected.
When prices and wages rise, the government collects more dollars in taxes. And it looks for them too. That’s because the economy gets bigger when measured in nominal dollars, while the face value of the old debt stays the same. It makes government debt easier to pay off.
For example:
A $1 trillion obligation is much easier to repay when government revenue has doubled. However, for the average American, the one saving for retirement, the bondholder still gets the promised dollars, but those dollars no longer buy the same amount of food, energy, housing or labour.
The name for this is a stealth default.
Negative Real Returns Do the Work
Here’s one example of how negative real returns work, and how the US government has used this strategy to support the government over time.
They use inflation, the money printer. Inflation is most useful to an indebted government when it runs above the interest rate on government bonds.
Suppose a Treasury bond pays 4 percent while inflation is 6 percent. The investor earns more dollars and loses about 2 percent in purchasing power.
According to the bond contract, the bond has been repaid in law, but in economic terms, part of its value was taken from the buyer. That’s what you call negative real interest rate.
Since 1971 the ten-year Treasury has paid less than inflation in 124 of 666 months, about one month in five. In March 2022 the gap reached 6.4 percentage points, the worst on record. From 2020 through 2023, real yields were negative 79 percent of the time. And that means, the average American with 10-year treasury bonds in their retirement portfolio were better off putting their money in a 1% yield cash savings account than investing in the US dollar.
Governments have used this method before, mostly after wars and financial crises. Most of the time, banks, pension funds and insurers are coerced or required to hold government debt, so there are buyers even when the real return is poor. Governments do it anyway. They deliberately hold interest rates below inflation and use regulations or incentives to keep banks, pension funds and insurers buying government bonds.
The entire system is called financial repression —> governments make their debt load easier to carry by shifting part of the burden onto savers and creditors.
The Unthinkable Gets a Syllabus
For over 80 years, treasuries have been treated as the world’s safest asset. A US debt default was unthinkable. Now it’s something economic professors are preparing students for.
A University of Virginia law class now asks students to plan a US debt restructuring. The assignment is titled “One Big Beautiful Default.” It imagines foreign investors abandoning Treasuries, interest rates climbing to 15 percent, and a president who wants to default on non-citizen bondholders while limiting the damage.
Axios reported on September 8:
An exercise in thinking about the unthinkable: a U.S. debt default
“I desperately hope that we don’t have to worry about it, but I think it’s really stupid not to prepare,” the professor said. The exercise reflects real anxieties about U.S. Treasury securities, traditionally seen as risk-free investments.
An outright default would hit banks, pension funds, foreign governments and nearly every financial market at once. It could also cost the dollar its reserve-currency status.
Inflating away the problem of default by adding more money into the system is less dramatic. It spreads the loss across savers, workers, consumers and bondholders without a formal announcement.
Paid in Full, Worth Much Less
The choice is between kinds of default…
The government can cut promised benefits, raise taxes, restructure bonds or…
Let inflation shrink the value of what it owes. Each method sends the bill to a different group.
Inflation wins politically because the transfer is harder to see, until it isn’t. There is no missed payment and no bankruptcy filing. Account statements keep showing that investors received everything they were owed.
But wealth is measured by what money buys, not by the number printed on your account statement. One hundred dollars meant you could buy a years worth(or more) of groceries back in the day. Today, $100 might mean a few days worth of food for a family of four.
Now, when you consider how much the US federal government, the latest $40 trillion mark changes nothing about how the debt gets paid. It only makes inflation more likely than taxation.
America may never miss a single Treasury payment. It may repay every bond, honour every coupon and return every promised dollar, but the default (negative real returns on bonds) will be hidden inside the dollar itself.
