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Why the USA Isn’t Going Bankrupt….

Here’s a common question I get via email:

“Can you explain why you don’t think the USA is going to have a Greek style debt crisis?”

Good question! This is one of those things that really confuse people because they understand how their own lives and businesses work as revenue constrained entities. But the currency issuer to household or business analogy doesn’t hold true. The reasoning is actually quite simple.

The USA has an institutional arrangement in which it is a contingent currency issuer. That is, while the Treasury is an operational currency user (meaning it must always have funds in its account at the Fed before it can spend those funds) it has the extraordinary power to tax and issue risk free bonds that the public will always desire to hold so long as inflation is not extraordinarily high. Additionally, in a worst case scenario, the US Treasury can always rely on the Federal Reserve to supply the funds necessary to fund its spending.  Imagine having your own bank that would always lend to you. This makes the government quite different from a household.

The key here is that there’s no solvency constraint as in, “running out of money”. Greece doesn’t have this arrangement. Since the ECB is essentially a foreign central bank there is a real solvency constraint and once Greece’s emergency funding line was cut off from the ECB it was forced to default on its IMF loan. So banks and private investors have become hesitant to buy Greek bonds because of this flawed institutional arrangement and the lack of an implicit guarantee. This is not comparable to the USA where the government has a domestic Central Bank which it harnesses.

This doesn’t mean the US government couldn’t one day run out of willing creditors due to economic weakness. In theory, the US government could find itself in a situation where financial markets do not want to hold US government bonds or US dollars. The government can always “fund” its spending by selling bonds to the Central Bank and essentially printing its own currency. So the government isn’t going to default on itself (assuming it has no foreign currency). But this crisis would materialize in the form of an inflation and/or foreign currency crisis. That’s quite different from a traditional solvency crisis which is what Greece is currently undergoing.

I would highly recommend reading the links at this page for more info:

Understanding the Modern Monetary System

Can a Sovereign Currency Issuer Default?


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