What Would a U.S. Debt Default Look Like?

It may now be a matter of "when", not if.

Photo by Debra Fisher on Unsplash

The U.S. has roughly 20 years to change course on the size of its debt, or a default of some form would become unavoidable, a Penn Wharton Budget Model stated in 2023.

That story was from 2 years ago, before the Big Beautiful Bill. That clock likely go accelerated.

The main problem is that we as human beings governed in a democracy like to have things while not necessarily, you know … paying for them. If we can have more stuff (the stuff varies depending on the political party in power) and put off paying, or put the burden of paying onto our children, we will take that option nearly every time.

Our leaders are happy to oblige us.

According to the Penn Wharton budget model mentioned above, no amount of tax hikes or spending cuts could prevent default if we continue on our current path (again, that analysis was from 2023).

Has the U.S. defaulted before? Yes … kind of.

In a 2021 op-ed in The Hill, Alex J. Pollock, a former Treasury Department official, argued that there have been four U.S. defaults in the past.

Pollock cited cases of the U.S. Treasury:

• Resorting to paper money largely not supported by gold during the Civil War in 1862;

• Redeeming gold bonds with paper money rather than gold coins during the Great Depression in 1933;

• Not honoring silver certificates with an exchange of silver dollars in 1968; and

• Abandoning the Bretton Woods Agreement in 1971, which included a commitment to redeem dollars held by foreign governments for gold.

None of these were earthshaking for the entire economy though. I don’t think the abandoning of the Bretton Woods system was a default. It was the end of a fixed exchange rate regime based on the U.S. dollar’s convertibility into gold. There was market turmoil because it was a big deal, but the U.S. still paid its bills.

A real default on the U.S. debt would have a much greater negative effect than any of these previous “defaults”. But do the research for yourself. I have never had “economist” on my business card.

So what would happen in a default?

Brush off those economics 101 textbooks and think about what such a default would mean.

In the short term we would have some flavor of financial crisis, a likely recession if not depression.

A default would lead to panic in the financial markets as investors would likely rush out of US Treasury bonds, which until that point, would have been one of the safest investments in the world. Other assets would tank as well, (stocks, bonds, real estate) but treasuries make the world go round. They are in your money market fund, and they are the “riskless” assets in your 401K or pension if the volatility of stocks and bonds is just too much for you. If these assets that have been relatively riskless for hundreds of years aren’t anymore, well, “Katy bar the door!”

The sell off of treasuries would decrease the demand for these bonds, which would sink in price. To induce people to buy those bonds, yields would need to go up - which means interest rates rising. Borrowing costs would spike a great deal overnight. Individuals, governments, businesses - everyone, would be faced with a large spike in borrowing costs, so economic activity would likely grind to a halt.

Credit markets would likely seize up because the safest place to put your money for nearly a century - US treasuries - would no longer be safe. Employment in the financial markets would collapse.

Over the mid to long term, everyone in the US would face higher interest rates and borrowing costs, as our rates are set from the treasury rates.

We would potentially get a debt death spiral, as the US national debt would need to increase to pay for programs, but because borrowing costs have gone up, we would need to offer higher and higher rates to creditors, which would just make the problem worse.

The US would lose a great deal of “soft power” as the adult at the financial table, and the richest nation in the world. The US has had the biggest say in how the global financial system worked since WWII. That influence would wain, if not drop precipitously. Investment in the US would decline, as would investment in many other places as the ripple effects of the US defaulting would be felt around the world economy.

If something cannot continue, it will stop.

That report from Penn Wharton said we had about 20 years max to deal with this problem. The national debt was about $36.2 trillion before the “Big Beautiful Bill”, which added about $3.3 trillion to that number.

We have considerably less than 20 years now.

But I can see the temptation for default.

After all, if the U.S. owes you $1 trillion, that is a U.S. problem. If the U.S. owes you $36.2 trillion, that is a YOU problem.

I can see a man with little understanding of how economics works, and who has benefited from declaring bankruptcy before, and has no interest in the welfare of the average American, deciding that default is the way to go, because he thinks someone somewhere else will feel the pain.

Be wary if you hear someone from the US government putting out “trial ballons” in the next few years saying things like. “We’ve defaulted before, and it’s been fine.”

By disaster or design, a post-growth world is coming.

I just thought it would be coming in a different way.

Hyperinflation

Let’s talk briefly about hyperinflation. Inflation will definitely be coming with the “Big Beautiful Bill” and tariffs, but a default on the debt would risk hyperinflation. Hyperinflation means out-of-control general price increases that result in extreme inflation.

Hyperinflation is rare, but it doesn’t just happen in Zimbabwe, Turkey or Venezuela. Hyperinflation has devastated China, Russia and Germany to name a few.

The story of Hyperinflation in Germany after WWI is instructive, if not a little bit terrifying. In 1922, it took about 160 German marks to equal one U.S. dollar. By November 1923 it took 4,200,000,000,000 market to equal one U.S. dollar. That’s 4.2 trillion. Money was all but worthless. The best story I’ve heard about that time was when a man used a wheelbarrow to take his money to the bank. While he was in the bank someone stole his wheelbarrow outside but dumped the money in it. The money was worthless. The wheelbarrow wasn’t.

What happened over the next 20 years in Germany?

Don’t think it can’t get worse. It can always get worse.