Several commentators have taken me to task, on mises.org and on social media, for suggesting that a T-bill is “a bond just like any other bond.” Don’t I know that Treasuries are the world’s reserve, “risk-fee” financial asset? Don’t I know the US dollar is the world’s reserve currency? Well, yes — having taught university-level money and banking and corporate finance, the capital asset pricing model, etc., I have a fair idea of what role T-bills and cash play in the world economy. I meant the above statement in the sense that you’d say, for example, “Ben Bernanke may be the second-most powerful man in the world, but he’s just a man like any other man, and puts his pants on one leg at a time.” Of course, Treasury bonds are special, because they’ve historically been backed up by the “full faith and credit” — i.e., the vast taxing and unlimited money-printing power — of the US government. Market participants rightly assume their default risk is very low (not zero, actually). Investors expect the US dollar to hold its value better than, say, the Zimbabwe dollar. But that doesn’t make either a magical thing, like a unicorn or an honest Congressman.
Ultimately, at the end of the day, when all is said and done — pick your favorite euphemism — a T-bill is a bond like any bond: a promise to pay principal and interest according to a specified schedule. The investor gets a return in exchange for bearing the risk that the borrower may not pay. If the borrower defaults — i.e., misses an interest payment, or tries to declare bankruptcy or otherwise restructure the debt — the lender will be worse off than before, the lender’s business may fail, and a number of harmful consequences may ensue. This happens all the time in private credit markets. The difference between corporate and municipal bonds and Treasury bonds is one of degree, not one of kind.
Moreover, the defaulting borrower will be harmed, having its credit rating lowered and finding its future borrowing costs higher than before. Again, the difference between the US Treasury and any other borrower is marginal. Missing a single interest payment, or even multiple payments, wouldn’t immediately make all US government debt worthless, it would just be worth less than before. Chinese and Japanese investors would be less likely to buy further bonds, but wouldn’t necessarily discontinue all lending to the US government. There’s no reason to expect bond or currency markets to “collapse,” let alone for the global economy to spin out of control in a giant meltdown. Indeed, there are markets for credit default swaps on sovereign debt — essentially, insurance contracts against default — including US Treasuries (currently, these markets think default highly unlikely, but not impossible). If financial markets can price out the risk of a sovereign default, how can default be a “black swan” event that market participants cannot possibly handle?
Here’s the most important point. Of course, I fully concede, a default of any kind would be harmful to individuals and institutions holding Treasury bonds in their portfolios. It would cause investors and analysts to rethink the role that T-bills play in the financial system and could cause some painful adjustments. But why should these be the only costs under consideration? What about the cost to the US taxpayer from raising the revenues needed to pay the interest on T-bills? What about the costs to everyone holding assets denominated in depreciating dollars — depreciation that will continue as long as the Fed maintains its policy of monetizing the debt? Why should all these people be penalized to benefit those who might be harmed from a loss on the value of Treasury bonds?
To paraphrase William Jennings Bryan: Why must humanity be crucified on a cross of the risk-free rate?
