I am wondering about the following (i) what are the real world implications of a debt default by the US gov’t, and (ii) any ideas about mitigation of this risk?
I am not looking to engage in a discussion of whether or not that will happen as that seems impossible to discern (and a rabbit hole) but more what smart folks see as what happens in the event that it occurs.
I realize this is all…supposition to a degree as it has never happened before but anyone have any guesses?
A default can only happen intentionally, so long as we borrow in our own currency. in 2011, S&P downgraded our sovereign debt from AAA, citing political dysfunction as their rationale. It was a stunning rebuke and one that I think doesn’t get enough attention, but it was basically yawned off by the markets. Truth is, US Treasurys are one of the world’s few risk liquid free assets and whether you rate them AA or AAA, the world financial system needs safe havens. Yes, you can buy debt of other highly rated countries and be basically risk free, but the market for German bunds, for example, is just not as large. You might not be able to sell at a good price when you need to.
A long time ago, I read am pamphlet by a bond market guru who imagined “A world without treasury securities.” His thesis, back in 2000, was that the Clinton surpluses would put an end to 30 year Treasury issuance (it actually had ground to a halt) and that the world financial system would have to look for other sources of safety and liquidity, as well as other benchmarks for managing risk. He thought this would be very disruptive. As it turns out, a recession, followed by 9/11 and deficit spending to covert two long wars brought Treasurys back, and this didn’t happen.
But, if we were to default, you would have similar conditions – Treasurys would no longer be "risk free’ by any stretch and liquidity would drain from the market. This would wildly disrupt global payments while the financial system looked for alternatives (Eurobonds? Japan?) and I would expect major failures of financial institutions. The dollar would lose value, earnings at international companies would be disrupted and we could get a reckoning over whether the dollar can be the world’s reserve currency going forward.
So, what would it make sense to own? I’d say no equities until the carnage is at its worst, and certainly no financial stocks anywhere in the world. There will be a temptation to buy foreign stocks but I think those will get killed, too. Debt instruments, including floating rate debt like leveraged loans or fixed rate corporate bonds will be dicey because nobody will know how to price them.
I do not believe in gold. I think that’s a religion.
But I would seek out hard assets like real estate (but, unleveraged), industrial commodities, and vital infrastructure like toll roads and ports. There might be opportunities in alternative yield like healthcare royalties or equipment leases, but I’d keep it simpler (and cheaper) than that and go for a commodities ETF.
Silver lining: I don’t think the Fed will allow this to happen. Even if they have to break a few laws to do it, I think they will use QE to stave off a technical default by monetizing our debt. If I were at the Fed, I wouldn’t ask permission and would say, “by all means, impeach me later.”
If you think a default is inevitable and want to make money on it happening, the play is to buy credit default swaps on US Treasurys, which will pay off in the event of a default. But the carrying cost is high.
Does the Fed see default as an economic problem or a political problem? Does the Administration see default as an economic problem or a political problem?
The Administration will see default as a political problem. If it can convince the Fed of the same (that actually shouldn’t be hard), then the Fed doesn’t intervene immediately.
But if short term chaos starts to transition to longer term chaos, the mettle of both the Administration and the Fed will be severely tested.
I am not sure I agree on your views regarding gold, sure there are price fluctuations throughout time, but its one of the oldest instruments in the history of mankind or at least within civil society when the concept of trading valued instruments began and gold has always stood the test of time as being a safe bet. However I wouldn’t recommend just buying Gold, but precious metals in general is a good bet along with looking into the other recommendations that you have put forth as some examples.
I also agree that a debt default is something I don’t see happening without the FED stepping in and taking action. We just witnessed BOE taking similar measures with the pension fund crisis creating the Sterling to lose value like crazy. Although things seem like they are leveling off for now its the uncertainty that may make liquidity and trade volume an issue in the short term. At worst, the value of the dollar will probably drop as a result of our debt but that is not necessarily a bad thing in the long term as it makes trading and speculation cheaper in order for the economy to regain its footing again.
Welcome MJA and look forward to more posts from you and thought provoking discussions.
I think I would look for stuff in other well-established economies that wouldn’t be too badly impacted by a US-based disruption. Because inside the US you would basically have a singularity. Might be a nothingburger, might be catastrophic (depending among other things on media coverage and public reaction.)
It’s not even clear what a default would look like – if it happens because of the debt limit, that means the treasury can’t issue new debt except as old debt is retired. There’s enough money coming in to retire old debt on a rolling basis, as long as you don’t keep paying other obligations, so it might “just” be like yet another government shutdown with no default on the bonds themselves. Or the executive branch might decide to default on bond payments to keep money flowing in other places.
I think the ultimate resolution of this will be from the Gang of Six, because you have laws all duly passed by congress that appear to conflict with one another: some require/authorize X amount of spending, another forbids borrowing to support that spending. I would not be surprised if, somewhere in the process, one of the new nutbars in the federal judiciary authorizes claimants to seize federal property in satisfaction.