you’re quite right. Technically the US cannot default because it can pay everyone back in USD. However, since USG needs to borrow money to fund it debt obligations, there may come a point where no one will buy treasuries leading to 15-20% interest rates or severe devaluation of the currency. While its not the same, in my mind the effect to the average American is pretty much the same.

Regarding your hypothesis on US defaulting on its debt, it’s been discussed ad nauseum by other financial experts as well as some MSM coverages. I have my own theory to debunk the hypothesis on why US will not default on its debt (not yet for at least in the next several decades).

First of all, US sells its debt obligation through Treasury auctions. If the auctions failed to have 100% asking, the Fed (which is different from the Treasury Department) buys the leftover Treasurys through the method of the printing press (electronically or paper). Therefore, there is no possible way that the auctions will completely fail since the Fed can act as a direct and total buyer of the Treasurys if no one else in the world is willing to touch them.

You might say to yourself, “This is stupid. Why do we have Treasurys in the first place? Why don’t we just as the Fed to print out a bunch of USD to cover our yearly budget deficits?” Well, you have to keep in mind that the Federal Reserve acts as an independent Central Bank outside the jurisdiction of the US Government (well, not completely independent but I’m not going into this). No one, and I do mean NO ONE, is entitled to print US Dollar EXCEPT the Federal Reserve. Therefore, the Fed has the power to control the USD money supply (all those M1, M2, etc that a lot of financial analysts are talking about) in this world.

The only way USG can operate year in and year out is for it to sell debt to finance its budget should it collects less (IRS) than it spends. Shoot, Clinton had it good for one year when IRS was able to collect more than what USG was spending (not sure if we had a bunch of Treasury auctions that year though…I’m not gonna bother checking). Treasurys are the only way for the USG to have an accounting liability (similar to that of public traded companies that have corporate bonds) for it to operate because, as I mentioned already, the Fed is an *independent* Central Bank and, although has the ability to print USD, will NOT print USD simply because USG fails to curb its appetite on spending.

Now, let’s come up with the worst case scenario of everyone, including foreign Central Banks, dumping Treasurys. What would happen? Well, the last entity in this world that would pick up all the Treasurys out there is the Fed and so the Fed will have to redeem all those Treasurys with, you guessed it, USD. Would that crash USD and makes it worthless. Theoretically, it will, but that’s not the point of this discussion. At least we can conclude from my statement above that those that sold Treasurys will get their money back in USD. That, to me, is not default.