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Bonds and default

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Many would agree that long-term bonds are safe and consider them as "risk free". But, I actually don't agree with this at all. What would happen if the United States government didn't have the money to pay back the bonds? If you remember towards the end of last year, the United States was at the edge of its seat wondering if the debt ceiling was going to be raised or not. If it wasn't raised, there was a possibility that the United States could default. That is a scary, scary thought in my opinion especially considering the US has a debt that is currently in the trillions.

The did end up coming up with a solution but its temporary. What are your thoughts on this? Do you think the US risks default in the near future or distant future? Can you imagine the impacts this could have?

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The United States debt currently stands at over $17 trillion. It is true that bonds in general are not risk free, as there is the risk of default on the bond, which would cause the investor to lose his/her investment. The United States government however, is not an ordinary entity. It has powers that ordinary people and businesses do not have. As you've mentioned, raising the debt ceiling is one way to avoid a default, albeit temporary. The United States government can use its powers in other ways to avoid a default. The most important of these powers will be outlined below.

Before discussing the government's current ability to pay back long-term bonds, first consider historically how the debt got to be $17 trillion. By understanding how the debt got to be so high, we may be able to understand how to decrease the debt, and hence ensure that bonds will be paid back.

Before I go on, I want to make sure you understand the difference between deficit and debt. They do not mean the same thing, although they are related. As an example for an individual, a deficit occurs when your monthly salary is greater than your monthly bills. The debt is the total amount you owe at any given time.

When Bill Clinton was president from 1993 to 2001, he had pushed large tax increases, including taxes aimed at high-wage earners, Medicare taxes, corporate taxes, and transportation fuel taxes. This occurred around the same time as a booming economy and the dotcom bubble, but our main focus here will be on the taxes collected, as the government has direct control over that. The tax increase together with the other factors turned a federal deficit into a surplus. The federal budget was balanced in fiscal year 2000. There was zero federal deficit. Even if ...

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J Pye, MSc
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  • MSc, California State Polytechnic University, Pomona
  • MBA, University of California, Riverside
  • BSc, California State Polytechnic University, Pomona
  • BSc, California State Polytechnic University, Pomona
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