March 4, 2012

The unthinkable might happen as it did in 1840: US default

The US government debt is still increasing as we speak - the US government have a plan to decrease the debt as we saw in an earlier post: Barack Obama and the US budget of 2013 - but who knows what might happen in the future? Another recession ignited by a war with Iran? Before this default might happen, it is a good thing to look what has happened before when US defaulted on its debt.

The national government has actually never defaulted, but what has happen is that several individual state governments have defaulted in the 1840s. After the war against the British in 1812 and in combination with investments in US infrastructure, the US increased its borrowing. In 1837, a financial panic occurred which culminated in a depression. By 1844, $60 million worth of state improvement bonds were in default.

The defaults did have some positive effects on the long-term side:
  • Major financial reforms - such as restricting state investments in private corporations and limits on the amount of debt governments could issue. These reforms had not probably happened if the state governments had been bailed out by the national government. Is a default the only way to prevent people from spending more money than they have?
  • The dollar did not collapse and investors were soon lending again to US states. The risk of another default decreases after the original default

One can also draw a parallel to the current Euro Zone crisis. The US is a similar currency union, and if the "US Zone" survived when some of its members defaulted in the 1840s, can the Euro Zone survive if Greece defaults?

Source: The American, Financial News Online