Consider the following statements :

Statement-I :
If the United States of America (USA) were to default on its debt, holders of US Treasury Bonds will not be able to exercise their claims to receive payment.

Statement-II :
The USA Government debt is not backed by any hard assets, but only by the faith of the Government.

Which one of the following is correct in respect of the above statements ?
(a) Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
(b) Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
(c) Statement-I is correct, but Statement-II is incorrect
(d) Statement-I is incorrect, but Statement-II is correct

Correct Answer: (b) Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I

Explanation:

Option (a): Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
- Incorrect: While both statements are correct, Statement-II does not explain Statement-I. Statement-I is about the inability of bondholders to exercise their claims in the event of a default, while Statement-II discusses the nature of the backing of US government debt.
Option (b): Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
- Correct: Statement-I is correct because if the USA defaults, holders of US Treasury Bonds will not be able to exercise their claims to receive payment . Statement-II is also correct as the US government debt is backed by the faith and credit of the government, not by hard assets . However, Statement-II does not explain Statement-I.
Option (c): Statement-I is correct, but Statement-II is incorrect
- Incorrect: Statement-II is correct as the US government debt is indeed backed by the faith of the government and not by hard assets .
Option (d): Statement-I is incorrect, but Statement-II is correct
- Incorrect: Statement-I is correct because in the event of a default, bondholders will not be able to exercise their claims .

Learn More

US Debt Default:
- Definition: A debt default occurs when a country fails to meet its debt obligations on schedule, which for the US would mean not making payments to US Treasury bondholders.
- Consequences: A default could lead to a significant downturn in financial markets, a surge in global interest rates, and a potential recession in the US .
- Historical Context: The US has never defaulted in the traditional sense, but there have been close calls, such as in 1979 due to a technical error.
US Government Debt:
- Nature: US government debt is backed by the full faith and credit of the government, not by hard assets .
- Debt Instruments: The US issues Treasury bonds, bills, and notes to finance its spending, which are considered safe investments due to their perceived stability .
- Debt-to-GDP Ratio: The US debt-to-GDP ratio is a key indicator of the country’s ability to repay its debt. As of recent data, it is around 100%, which is a cause for concern among economists .
Risks of Default:
- Economic Impact: A default could shave around 4% from US GDP, cause stock prices to fall by a third, and result in significant job losses.
- Legal and Financial Ramifications: The US government would face legal challenges and increased borrowing costs, and its credit rating could be downgraded.
Debt Ceiling:
- Definition: The debt ceiling is the maximum amount the US government can borrow to meet its legal obligations .
- Historical Adjustments: The debt ceiling has been raised or suspended numerous times to prevent default and ensure the government can meet its financial obligations .