Question map
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 ?
Explanation
The correct answer is option A because both statements are accurate and Statement-II explains Statement-I.
Treasury securities are backed by the full faith and credit of the United States, meaning that the government promises to raise money by any legally available means to repay them.[1] This confirms Statement-II is correct—US government debt is not secured by tangible hard assets like land or gold, but only by the government's promise to honor its obligations.
Statement-I is also correct because in the event of a US government default, bondholders would face significant difficulty enforcing their claims. Lenders may demand collateral (security) against loans. Collateral is an asset that the borrower owns (such as land, building, vehicle, livestocks, deposits with banks) and uses this as a guarantee to a lender until the loan is repaid. If the borrower fails to repay the loan, the lender has the right to sell the asset or collateral to obtain payment.[2] Since US Treasury bonds lack such collateral backing, bondholders cannot seize specific assets to recover their money.
Statement-II directly explains Statement-I: the inability to enforce claims upon default exists precisely because the debt has no hard asset backing—it relies solely on governmental faith and credit.
Sources- [1] https://en.wikipedia.org/wiki/United_States_Treasury_security
- [2] Understanding Economic Development. Class X . NCERT(Revised ed 2025) > Chapter 3: MONEY AND CREDIT > TERMS OF CREDIT > p. 43
PROVENANCE & STUDY PATTERN
Full viewThis question is a classic 'Headline to Textbook' conversion. The 2023-24 US Debt Ceiling crisis was the news; UPSC didn't ask about the ceiling limit but tested the fundamental definition of 'Sovereign Debt' (Fiat nature) vs 'Secured Debt'. It rewards conceptual clarity over fact-hoarding.
This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.
- Statement 1: If the United States government were to default on its debt, can holders of US Treasury bonds legally enforce claims to receive payment?
- Statement 2: Is United States government debt backed by any hard assets, or is it backed only by the government's "full faith and credit" (i.e., not by specific hard assets)?
- Statement 3: Does the absence of hard-asset backing (being backed only by "full faith and credit") explain why Treasury bondholders would be unable to enforce payment in the event of a US government default?
Provides a clear definition of 'default' as non-payment when any part of the debt is due and not repaid — a legal characterization of the event.
A student could combine this definition with knowledge of US Treasury bond payment schedules and court systems to ask whether non-payment meets legal criteria for remedies.
States that a debt security represents borrowed money that 'must be repaid' with defined terms for amount, interest and maturity — implying contractual rights of holders.
Use this rule plus basic contract law principles (e.g., creditors' rights) to explore whether Treasury holders would have enforceable contractual claims in court.
Defines government-issued bonds as debt instruments used to borrow funds for a defined period, treating them analogously to other bonds.
A student could extend this by comparing legal remedies available to private bondholders (e.g., suing for breach) to those potentially available against a sovereign issuer like the US.
Explains 'debt restructuring' and that creditors may have to accept haircuts or swaps — an example of negotiated outcomes when borrowers face distress.
Combine this pattern with the possibility of sovereign distress to consider that enforcement might be altered by political or negotiated processes rather than simple court-ordered payment.
Gives a definition of legal tender as money a creditor is under compulsion to accept — relevant to what forms of payment might discharge debt obligations.
A student could use the legal-tender concept plus knowledge of US currency and courts to examine whether offering legal-tender currency affects enforceability or discharge of Treasury claims.
- Explicitly states U.S. Treasury securities are backed by the government's 'full faith and credit'.
- Explains that backing means the government promises to raise money by any legally available means to repay them (not by specific physical assets).
- Reiterates that Treasury bonds are backed 'by the full faith and credit of the United States'.
- Uses this phrase to justify Treasuries' status as low-risk, implying the backing is the government's credit rather than hard assets.
- Contrasts types of bonds: notes that 'U.S. securitized bonds' are typically backed by hard assets or loans.
- By distinguishing securitized (asset-backed) bonds from other bond types, it supports the view that Treasuries are not asset-backed but credit-backed.
States a general rule that governments can raise resources through taxation and by issuing/printing money, implying government debt is supported by the state's ability to tax and create currency rather than by specific physical collateral.
A student could combine this with basic facts about the US federal government's taxation power and the dollar-issuing authority of the Federal Reserve to judge whether debt relies on assets or on fiscal/monetary capacity.
Defines 'capital receipts' and distinguishes debt-creating receipts (loans) from sales of assets that reduce the government's financial assets — showing the conceptual difference between borrowing and asset-backed financing.
A student could check whether US Treasury borrowing is recorded as debt-creating receipts and whether the US holds specific assets sold/pledged to back Treasury bonds.
Gives an example of sovereign guarantee (Central Government providing guarantees for state borrowings), illustrating that governments can guarantee debt rather than pledge hard assets.
One could compare whether US federal debt carries similar sovereign guarantee language or instead references specific pledged assets.
Explains NIIP treats government liabilities (debt) separately from assets, implying national debt is an item of liability on government balance sheets distinct from physical or financial assets held by the country.
A student could look up the US government's balance sheet (assets vs liabilities) to see if Treasury debt is offset by designated hard assets or by general net assets.
Notes that debt owed to foreigners creates obligations to transfer goods/services, highlighting that debt represents future payment commitments rather than immediate asset-backed claims.
A student could use this to reason that government bonds create future-claim obligations (serviced by revenue) rather than being secured by particular hard assets.
- Defines secured debt and security interest as a right upon property created in favour of a secured creditor, implying secured creditors can claim specific assets.
- Contrasts secured creditors (with property claims) against general concept of default as non-payment, suggesting lack of such a security interest reduces enforceable remedies.
- Explains collateral is an asset the borrower uses as guarantee and that lenders may sell collateral if borrower fails to repay.
- Implies that without collateral (i.e., only 'faith and credit'), lenders lack the automatic right to seize assets to obtain payment.
- [THE VERDICT]: Conceptual Application (Medium). Source: General Macroeconomics principles applied to Current Affairs (US Debt Ceiling).
- [THE CONCEPTUAL TRIGGER]: The global buzz around the 'US Debt Ceiling Crisis' and the potential for a historic US default.
- [THE HORIZONTAL EXPANSION]: 1. Definition of Fiat Money vs. Fiduciary Money. 2. Indian Sovereign Debt: G-Secs (Tradable) vs. Small Savings (Non-tradable). 3. 'Original Sin' in Economics (borrowing in foreign currency). 4. Article 292 vs 293 (Borrowing powers of Center vs States in India). 5. Concept of 'Risk-Free Gilt-Edged Securities'.
- [THE STRATEGIC METACOGNITION]: When a major economy faces a crisis (e.g., US Default), do not just read the news updates. Ask the structural question: 'What legally happens if a government defaults?' and 'What backs this debt?' Connect it to the static definition of Fiat currency in NCERT.
Government bonds are debt instruments that create an obligation to repay principal and interest to holders.
High-yield for UPSC: mastering the legal and financial nature of sovereign bonds helps answer questions on fiscal sustainability, market functioning and investor rights. It links fiscal policy to capital markets and enables analysis of sovereign liability, creditor priorities and debt instruments versus equity.
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 9: Agriculture > Bonds > p. 264
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.4 Securities > p. 42
Default is defined as non-payment of debt when any part of the amount has become due and is not repaid.
Essential for questions on sovereign distress and debt crises: knowing the technical meaning of default allows clear distinction between delay, restructuring and legal default, and informs discussion of remedies like restructuring or write-offs.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 3: Money and Banking - Part II > 3.6 Categorization of Loans > p. 135
Government bonds are often treated as risk-free instruments and large-scale government borrowing affects private investment via crowding out or crowding in.
Important for UPSC essays and economics answers: explains why sovereign default is rare, how markets price government debt, and the broader economic consequences of high public debt—connecting public finance to investment, interest rates and monetary policy.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 4: Government Budgeting > 4.8 Perspectives on Deficit and Debt > p. 158
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 5: Government Budget and the Economy > Debt > p. 78
Governments can repay and service debt by raising resources through taxes and by creating money, rather than by pledging specific hard assets.
High-yield for public finance questions: explains the practical basis of sovereign debt repayment capacity, links to fiscal policy and monetary policy interactions, and helps answer questions about sustainability of government debt and sources of repayment. Useful across questions on budget deficits, inflationary risks, and central bank-government relations.
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 5: Government Budget and the Economy > Debt > p. 78
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 5: Government Budget and the Economy > Debt > p. 79
Government borrowing increases future liabilities, while selling public assets reduces the government's stock of financial assets and future earnings.
Important for budgeting and balance-sheet analysis: helps compare debt-financing with asset-disposal financing, informs questions on capital vs revenue receipts, and aids evaluation of long-term fiscal implications of privatization or borrowing. Connects to public debt sustainability and fiscal accounting.
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 5: Government Budget and the Economy > 5.1.2 Classification of Receipts > p. 69
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 5: Government Budget and the Economy > Debt > p. 79
The phrase 'Full Faith and Credit' appears in constitutional contexts as a clause for legal recognition of public acts and records, not inherently as a statement about backing of government debt by hard assets.
Useful for constitutional-law and public finance linkage: distinguishes legal/constitutional terminology from financial concepts, preventing category errors in answers. Helps handle questions that bridge polity and economics (e.g., sovereign guarantees, intergovernmental borrowing).
- Indian Polity, M. Laxmikanth(7th ed.) > Chapter 16: Inter-State Relations > PUBLIC ACTS, RECORDS AND JUDICIAL PROCEEDINGS > p. 169
- Laxmikanth, M. Indian Polity. 7th ed., McGraw Hill. > Chapter 16: Inter State Relations > PUBLIC ACTS, RECORDS AND JUDICIAL PROCEEDINGS > p. 169
Whether a creditor can enforce payment depends on whether the debt is secured by a security interest in specific property or is unsecured.
High-yield for UPSC questions on sovereign debt and creditor rights: explains legal remedies available to lenders, links public finance to legal frameworks on collateral and insolvency, and helps answer why sovereign debtors differ from private borrowers in enforcement mechanics.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 3: Money and Banking - Part II > 3.6 Categorization of Loans > p. 135
The Indian Parallel: Under Article 292, the Government of India borrows upon the security of the Consolidated Fund of India. Unlike the US, India has no statutory 'Debt Ceiling' (though FRBM Act suggests targets), making the 'limit' a policy choice rather than a hard legislative wall.
The 'Cause-Effect' Lock: Read Statement II first. If debt is NOT backed by assets (Statement II), then logically, there are no assets to seize to satisfy a claim (Statement I). Statement II provides the *mechanical reason* for Statement I. This strong causal link usually points to Option A.
Mains GS-3 (Economy) & GS-2 (IR): This links to 'De-dollarization'. Since US debt is backed only by 'faith' (and military/economic dominance), any erosion of that faith (via weaponization of sanctions) encourages countries to diversify reserves (Gold, Yuan), threatening the US Dollar's status as the global reserve currency.