The United States Treasury Bill — an IOU issued by the federal government — has long been considered a risk-free investment. It may not offer a high return these days but at least you’re sure to get your money back, they say. After all, the U.S. has never defaulted on its debt in its 240-year history.
In studying the 16-year long saga of Argentina’s default (which began in 2001), UCLA economics professor Sebastian Edwards frequently heard this view expressed, only to discover that it was not true.
His new book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold (Princeton University Press, 2018) documents a forgotten episode in which the U.S. technically defaulted on its debts in the form of President Roosevelt’s 1934 devaluation of the dollar.
Most economists agree that the Great Depression was worsened by the collapse in prices — especially commodity prices — which made it impossible for farmers and others to earn a reasonable living or pay back their loans. The sudden rush by the public to hoard gold depleted the financial system of the backing for money, leading to a rapid deflation that crushed borrowers beneath burdensome debts.
One solution, widely acknowledged since Milton Friedman and Anna Schwarz’s Monetary History of the United States, is to create inflation by printing money and devaluing the dollar. However, lending contracts in the 1930s period frequently contained a clause that required debts to be paid back in gold or gold-equivalent. This meant that any devaluation attempt would correspond to even higher dollar payments, sinking debtors even further into debt.
FDR improvised, and on the urging of a heterodox economist named George Warren doubled the price of an ounce of gold with the stroke of a pen, while simultaneously abrogating the gold-backing clauses that would have otherwise thwarted his plan.
Buy the book: American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold. Princeton University Press, 2018, Sebastian Edwards
Oddly, Friedman and Schwarz largely neglected this vital chapter of the Great Depression. The first book-length study of the dollar devaluation, American Default splits its focus between the economics and the legal challenges of FDR’s devaluation. 68 pages are dedicated the Supreme Court decision — frequently read in law schools — that upheld FDR’s move as constitutional, since the U.S. still technically paid back its creditors (albeit in devalued dollars).
If this doesn’t debunk the notion that default could never happen here, we might take a look at the U.S. government’s debt as a percentage of GDP. Edwards notes that his colleagues Carmen Reinhardt and Kenneth Rogoff’s research shows that 90% debt-to-GDP ratios have been the historical tipping point triggering default in places like Turkey, Argentina, Mexico, Russia and Chile.
We’ve been watching Venezuela’s slow-motion meltdown at the hands of populist macroeconomics. Could such a fate await the United States if we continue down the path of unsustainable entitlement spending?
Sebastian Edwards joined me for the full hour to discuss his research on the politics and economics of FDR's devaluation, and the parallels to the populist macroeconomics of today.