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Ok sorry guys, this might be a "simple question", but simple questions can lead to big insights nevertheless. So I want to be an investor in the global stock market, and the biggest part of that is US stocks. And as an investor it's my obligation to understand the risks. Yes, my fear is they might default in one of the next decades and my US stocks (which would be like 40% of my personal wealth) goes up into smokes.

Typical arguments: Of course I have informed myself and the standard answer is "this is never going to happen". Ok probably true, but that's no argument and does not fulfill my obligation. The other argument is: They won't do it, because it will raise their interest rate. This argument I can't understand. Let's say you cut your foreign debt by 90%. Logically, only if your interest rate rises by more then 10x, your new principal payment is higher than before. Is there any data that interest rates will long term go 10x? Also, you could say: Hey I have no foreign debt, my debt to GDP ratio has improved. Is there any data / arguments that disputes my logic?

My take on this (is this logic right?): If the US was a person that earns 100 dollars a day, defaulting on their foreign debt payment would save this person around 1 dollars a day, so not much. Now the only question is if they gain or lose more than one dollar in total with this move? So we have two cases:

Case a) Defaulting costs the US more than 1% of their GDP. This would mean their total income would shrink. So the US won't do it and US investments are safe.

Case b) Defaulting costs the US less than 1% of their GDP. In this case the US could do it, but as the consequence is less then 1% of US GDP, so my investment in US and global stocks would not suffer a big loss or even is going up as the total GDP of US rises. US investments are safe.

In summary: I don't need to trust the US government to not hurt foreign investors. I only need to trust them to not shoot themselves in the foot. My aim with this post is to gain trust into a globally diversified stock portfolio through understanding why the US will never default.

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    $\begingroup$ Would it help you to know that most of US stock payments are not made by the US government, a federal default would only directly affect bonds (not stocks)? $\endgroup$
    – Giskard
    Commented Sep 18, 2023 at 20:35
  • $\begingroup$ Well sure it helps a little bit! So to me it looks like: US default -> "something happens I don't completely understand" -> the world goes up in flames. But then again ... if the world goes up in flames and they are like 60% of the world in terms of stocks, why would they do this, right? So I basically just need to trust them not to set their own house on fire. $\endgroup$
    – Sport-ask-guy
    Commented Sep 18, 2023 at 21:21
  • $\begingroup$ The OP refers to foreign debt. US doesn’t have much of that. Nearly all USD denominated. $\endgroup$
    – dm63
    Commented Sep 19, 2023 at 3:43
  • $\begingroup$ @dm63 USD denominated, yes, but another definition, and the usual definition of "foreign debt" is debt held by foreigners. US federal debt held by foreigners in Q4 2022 was 7.3 T USD. $\endgroup$
    – H2ONaCl
    Commented Sep 19, 2023 at 6:30
  • $\begingroup$ Yes I mean held by foreigners. Default on domestic debt won't work because it will hurt them too much and because of the justice system. Right now defaulting foreign debt also probably will not work because of their justice system, but I was not 100% sure about that one. $\endgroup$
    – Sport-ask-guy
    Commented Sep 19, 2023 at 10:28

2 Answers 2

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US doesn’t need to ever default if it doesn’t want to.

For any country borrowing in its own currency default is purely optional. Because a country that borrows in its own currency can always just issue more currency to pay for the debt (outside of rare instances when physically country is not able to create more currency but in digital age that’s less of an issue).

However, such country might still choose to default. This is because doing the above also has negative macroeconomic consequences (eg inflation, see Mankiw Macroeconomics, pp 79-119). This will occur at a point where costs of monetizing debt are higher than the extra cost country will be forced to pay for new debt after default. There is no precise number that can be given for the threshold. As a consequence it’s impossible to say whether US will default or not in the future. Current US bond ranking is between AA+ and AAA indicating that rating agencies think US default is extremely unlikely.

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  • $\begingroup$ Isn't the interest rate paid on US Treasuries ultimately dictated by the fed's rate? It would be a government policy decision to pay higher and higher debt interest. What would the US government prefer: issue safe storage for dollars at super high interest rates, thereby shifting wealth upwards, or keep the storage option but at low rates and instead manage inflation in other ways. All these things are always political decisions. $\endgroup$
    – Jamie Smith
    Commented Oct 11, 2023 at 11:02
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    $\begingroup$ @JamieSmith what do you mean by ultimately? Interest on treasuries is equal to risk free interest rate + risk premium. Fed controls the risk free rate. For a given level of fed interest the interest will be determined by risk premium. Every way of controlling inflation involves some changes to the costs of funds the question is just where they are hiding $\endgroup$
    – 1muflon1 ♦
    Commented Oct 11, 2023 at 11:14
  • $\begingroup$ Yes, I mean the risk-free rate set by the fed places a floor on bond yields on issuance. But there is nothing stopping the fed issuing bonds at a set rate and accept applications at that rate. If primary dealers don't want the bonds at that low rate, so be it, they won't be issued. The possible flood of reserves would push interbank rate down to the fed rate. I doubt that would be a huge macroeconomic issue. Gov could suppress bank credit in other ways than just crude monetary policy (eg. more stringent credit check requirements, processes to slow the velocity of credit, etc). $\endgroup$
    – Jamie Smith
    Commented Oct 11, 2023 at 11:22
  • $\begingroup$ @JamieSmith that kind of aggressive monetization of a debt will result in large inflation under virtually any macroeconomic model and high inflation can be very costly for an economy $\endgroup$
    – 1muflon1 ♦
    Commented Oct 11, 2023 at 12:00
  • $\begingroup$ Really? Can you explain to me the precise mechanisms that would feed into inflated prices in the economy in this scenario? $\endgroup$
    – Jamie Smith
    Commented Oct 11, 2023 at 13:02
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It’s an interesting question as to whether US would ever selectively default to foreign holders of US Treasuries. To do so would clearly discourage foreign buyers from ever purchasing Treasuries in the future, which in turn would discourage them from accumulating US dollars, which would then discourage them from exporting goods to the US. Overall, disastrous impact. I suppose there could be a situation where US is at war with a foreign power that holds US Treasuries. In that case there seems to be precedent that US dollar assets are frozen, rather than completely confiscated. Eg Russia.

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  • $\begingroup$ I would say that it's unlikely the US trade deficit with the rest of the world will be wiped out if the US government stopped issuing bonds (or indeed stupidly stopped paying the aggreed coupon payments). Therefore, dollars would still find their way into foreign hands. Demand for which is surely high irrespective of the US Treasury market. $\endgroup$
    – Jamie Smith
    Commented Oct 11, 2023 at 10:57
  • $\begingroup$ Let’s hope this never gets tested $\endgroup$
    – dm63
    Commented Oct 11, 2023 at 12:23

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