Named default scenarios in the US

US President Joe Biden, addressing the American people on May 17, said that there is no reason to worry about the possible default of the United States on their huge national debt, since there have never been defaults on public debt in this country, and never will be. But this is not so: in fact, the default on bonds in the United States was declared not even once, but as many as five. Two of them took place in the 18th century, one in the 19th century, and two more in the 20th century: in 1934, as a consequence of the Great Depression, and another in 1979.

The last US default on government debt was technical not only figuratively, but also literally, as the US Treasury was unable to pay the coupon on bonds on time due to a technical failure that was fixed within a few days. Now Biden and representatives of the US Congress are trying to calm the population, stating that the parties have the opportunity to reach an agreement on public spending and the size of the national debt ceiling before June 1, so that America is no longer threatened with a default (at least until the next ceiling is reached).

How reliable are US government bonds today? A very important indicator of the degree of reliability of investments in bonds (that is, the probability of default on them) is the credit rating of these securities, and if these bonds are issued by the state, then the credit rating of the country. In March of this year, the international rating agency S&P Global Ratings, carrying out a periodic review of country ratings, maintained the US credit rating at AA +, with a “stable” outlook.

Such a rating means that the probability of the country’s default on public debt in the near future is very low, but there are long-term risks that can increase this probability (and, accordingly, lower the rating). As such a risk, S&P calls the very large size of the US government debt (currently it is $ 31.46 trillion, which exceeds the size of US GDP by more than a third).

For a bond investor, it is also important to pay attention to the yield of the bond and its dynamics. The yield on different issues of US government bonds is not too high, 2-4% per annum, which is the norm for bonds of developed countries. But in the last year, when the US Federal Reserve has been continuously raising interest rates (and raising or lowering interest rates by the Central Bank directly affects bond yields), yields on US government debt began to change with distortions: yields on less risky (theoretically) short-term bonds with maturities in 5-7 years exceeded the yields of riskier long-term government bonds maturing in 30 years.

Many American economists, as well as investment banks, consider such distortions in profitability an indicator of a future economic crisis or serious problems already existing in the US economy (a similar phenomenon was observed in the 21st century in the US in 2008 and 2015, on the eve of global economic crises). Thus, despite the continued high credit rating of US government bonds, today it is more and more difficult to call investments in US government debt investments of increased reliability.

Nevertheless, the probability of a US default, even a technical one, after June 1 this year, we believe is extremely low. In fact, the real reason for the imminent failure of the US authorities to pay their debt lies in the disagreement between the legislature and the executive on the issue of government spending. The probability that at the last moment the US Congress and the Biden administration will come to an agreement on the size of the future debt ceiling and government spending cuts is very high.

A similar case already took place in the summer of 2011, when the representative of the Democratic Party, Barack Obama, also held the presidency of the United States: the day before a possible default, the administration nevertheless managed to agree with Congress on measures mutually satisfying the legislative and executive authorities to reduce the budget deficit, and then Congress allowed the executive branch to raise the debt ceiling by 2.1 trillion. Another similar case took place in 2018, when Republican Donald Trump was already in the presidency, but at the last moment Congress and the presidential administration agreed on government spending and the national debt ceiling was again increased. Most likely, this year the situation with the increase in the national debt ceiling in the United States will come to the same denouement – Congress once again will allow to continue to increase the already swollen public debt.

However, reaching an agreement between the legislative and executive branches of government in the United States on the issue of public debt will not mean that such a problem will not arise in the future. Over the past 32 years, the US government debt has grown 10 times, today its size exceeds the size of the entire US GDP, and in fact, the US government debt is already being serviced thanks to the issuance and sale of new government bonds on the market. The credit rating of US government bonds AA + from S&P very accurately reflects the real situation with US government debt: there are no reasons to run away from US government bonds yet, but you should start thinking about the fact that the reliability of such securities is not eternal.

Well, if the negative scenario does materialize and the US defaults on bonds happen tomorrow, what will happen to the global economy? A technical default, that is, a delay in bond payments, looks a little more likely than a real default. In this case, massive sales of US bonds will begin, their yields will rise sharply, and rating agencies will downgrade the rating and, possibly, the forecasts for the rating of the US government debt. But a technical default scenario may work differently than we imagine today.

For example, the US news agency Bloomberg has calculated that the X hour for servicing the US national debt will not come on June 1, but five days later. If this is the case, then the date of the US technical default could move forward by a few days, during which time Congress and the White House will have much more opportunity to reach an agreement. In any case, a short-term delay in payments on government debt can only adversely affect the reputation of the United States as a borrower and lead to a downgrade of US government bonds without any serious consequences for the global economy.

But if the US default turns out to be completely non-technical, and the government really cannot service its debts, not only the American, but the entire world economy will have problems. First, the dollar, which, according to the International Monetary Fund, still holds almost 60% of the international reserves of central banks around the world, will collapse, and, accordingly, the reserves of many central banks will depreciate.

Second, the largest holders of US bonds, such as the governments of the UK, Japan, and China, will start dumping these bonds en masse on the exchange, causing their prices to collapse, and the yields, respectively, will rise to double digits, corresponding to the yields of bonds of small and high-risk companies. , or bankrupt states, called “junk bonds”.

Thirdly, the collapse of the dollar and the US national debt could lead to a catastrophic recession in the American economy, and hence to a significant recession in the entire global economy. Not to mention that the consequence will be a collapse in prices in all world commodity markets, including oil and gas prices. That is, it can be assumed that events will develop according to the scenario of the spring and early summer of 2020, when the whole world suffered from the coronavirus pandemic and the associated restrictions on the economy. This means that both the Chinese and Russian economies may also suffer significantly. Fortunately, the predicted probability of just such a development of events is estimated very low, from zero to 0.5-0.6%.

Despite the fact that the apocalyptic scenario of the development of events is very unlikely, Russians today should think about the rather high risk of investing in US government bonds. Moreover, for several reasons: starting with the fact that, due to sanctions, the bonds of the governments of countries unfriendly to Russia can simply hang in the depository, something like what happened with the shares of American and European companies owned by Russian investors, and ending with the fact that US government bonds today are not as reliable an investment of capital as it was, say, back in the 20th century.

That is, the risks of investing in such securities are now quite material, the profitability is low, and there is also the possibility of losing money in American securities solely for sanctions reasons. And the US dollar, and therefore dollar assets for Russians, is also now toxic, and to this is added the hypothetical possibility of a fall in the dollar if America really begins to have serious problems with servicing the public debt. So, before deciding to convert your ruble savings into dollars, you should think carefully. Still, it is better to keep funds in rubles and yuan, provided that Russian banks do not charge fees for holding funds in foreign currency, and also to purchase securities of highly reliable Russian issuers.