History Notes Special: US Debt Default of 1932

In 1933, when the US defaulted on the debt to the banks; the banks decided that the Constitutional Republic was over, so they chose a new form of government for the US corporation—a Democracy.

As the bailouts in the current bust inexorably mount, financed in rapidly increasing U.S. government debt, one might wonder whether a default on Treasury debt is imaginable. In the course of history, did the U.S. ever default on its debt?

Yes.

From University of California, Los Angeles economist Sebastián Edwards’s book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold.

Edwards argues that the United States defaulted on federal debt during the 1930s when it withdrew monetary gold from circulation and abrogated the gold clause in both public and private contracts.

The United States clearly defaulted on its debt as an expediency in 1933, the first year of Franklin Roosevelt’s presidency. This was an intentional repudiation of its obligations, supported by a resolution of Congress and later upheld by the Supreme Court.

The narrative starts in March 1932, during the economic downturn now known as the Great Depression. Nearly a quarter of the labor force experienced unemployment. Commodity prices declined by more than half. These declines proved particularly hard on people running small businesses, such as family farmers who made up a quarter of the U.S. population. Declining farm prices accentuated farmers’ debt burden because the nominal value of debts remained fixed, forcing farmers who wanted to pay their mortgages and crop loans to double production (which was often impossible) or cut consumption (particularly of durable goods like cars, radios, and clothing). Some farmers (and eventually almost all farmers) stopped paying their debts, defaulted on their loans, and faced bankruptcy, which often resulted in the loss of lands and livelihoods.

In 1932, government finance still had a real tie to gold. In particular, U.S. bonds, including those issued to finance the American participation in the First World War, provided the holders of the bonds with an unambiguous promise that the U.S. government would give them the option to be repaid in gold coin.

Nobody doubted the clarity of this “gold clause” provision or the intent of both the debtor, the U.S. Treasury, and the creditors, the bond buyers, that the bondholders be protected against the depreciation of paper currency by the government.

Unfortunately for the bondholders, when President Roosevelt and the Congress decided that it was a good idea to depreciate the currency in the economic crisis of the time, they also decided not to honor their unambiguous obligation to pay in gold. On June 5, 1933, Congress passed a “Joint Resolution to Assure Uniform Value to the Coins and Currencies of the United States,” of which two key points were as follows:

• “Provisions of obligations which purport to give the obligee a right to require payment in gold obstruct the power of the Congress.”
• “Every provision contained in or made with respect to any obligation which purports to give the obligee a right to require payment in gold is declared to be against public policy.”

In plain terms, the Congress was repudiating the government’s obligations. So the bondholders got only depreciated paper money. The resulting lawsuits ended up in the Supreme Court, which upheld the ability of the government to refuse to pay in gold by a vote of 5-4.

The Supreme Court gold clause opinions of 1935–the majority opinion, written by Chief Justice Hughes:

• “The question before the Court is one of power, not policy.”
• “Contracts, however express, cannot fetter the constitutional authority of the Congress.”

Justice McReynolds, writing on behalf of the four dissenting justices:

• “The enactments here challenged will bring about the confiscation of property rights and repudiation of national obligations.”
• “The holder of one of these certificates was owner of an express promise by the United States to deliver gold coin of the weight and fineness established.”
• “Congress really has inaugurated a plan primarily designed to destroy private obligations, repudiate national debts, and drive into the Treasury all gold within the country in exchange for inconvertible promises to pay, of much less value.”
• “Loss of reputation for honorable dealing will bring us unending humiliation.”

The clearest summation of the judicial outcome was in the concurring opinion of Justice Stone, as a member of the majority:

• “While the government’s refusal to make the stipulated payment is a measure taken in the exercise of that power, this does not disguise the fact that its action is to that extent a repudiation.”
• “As much as I deplore this refusal to fulfill the solemn promise of bonds of the United States, I cannot escape the conclusion, announced for the Court, that the government, through exercise of its sovereign power, has rendered itself immune from liability.”

Under sufficient threat, crisis and pressure, a clear default on Treasury bonds did occur.