A Note on Sovereign Debt

A recent article, posted on Yahoo! News that discussed the possibility of the United States defaulting on their debt caught our attention, but only because of the misinformation that was implied. The United States Treasury currently owes approximately $14 trillion. (Click here for debt clock) The article suggests that if and when the US government defaults, debt holders will be able to take control of US assets.

The debt that is issued by sovereign nations is in the form of debentures, not bonds. The difference is that a bond is secured by a lien on a certain asset. In the event of default, the bond holder has the right to take possession of that asset. In this respect, a bond is similar to a mortgage. Stop paying your mortgage and the lender gets to take your house through foreclosure. A debenture, however, is not secured by any specific asset, but rather, is a claim on all assets. In the event of a default, assets are sold to meet the demands of debenture holders. In the event of a US default, debt holders are not entitled to seize ownership of Chicago.

Looking at the top 10 list, no regular reader of this blog should be surprised to see China in the number one spot. To keep the value of the yuan low, the Chinese government must continually buy up the excess supply of US dollars that result from the trade imbalance. These are held in the form of US government debt. The same is true of the Brazilian holdings. That country’s government is trying to prevent their currency from rising as well. Oil exporting countries also have a trade deficit with the US and thus hold US debt.

The Caribbean Banking Centres seems to surprise the author, but not us. Banks exist in the Caribbean to avoid taxes in the United States. Their deposits (liabilities) are predominantly in US dollars and therefore to avoid currency risk, most of their assets (debt instruments for example) should be held in US dollars. An educated guess would be that banks in Jersey and Guernsey would hold large amount of UK debt, and banks in the Seychelles would hold large quantities of euro denominated debt.

One last thing that the article does not mention is that the US government owes 14 trillion US dollars and the US Federal Reserve has the unlimited authority to print US dollars. If the world’s creditors demanded instant repayment of the entire outstanding debt, the US could simply turn on the printing presses and print $14 trillion. Note that this is not an option for the European PIIGS since they don’t have the authority to print euros.

We are currently negotiating with the US government to take control of Fort Zachary Taylor State Park as payment for our debt holdings. Not having much luck.