What Happens If The US Defaults?
The Dynamic Wealth Report
July 25, 2011
by Robert Morris, Editor
The debate in Washington over raising the debt ceiling took a nasty turn
at the end of last week.
Speaker of the House, John Boehner, walked out of negotiations on
Friday. Apparently, the White House tried to slip in another $400
billion in tax increases at the last minute. (Republicans had already
proposed increasing taxes by a whopping $800 billion!)
And the Democrat controlled Senate used a procedural maneuver to kill
the House approved Cut, Cap, and Balance Act without a real vote.
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These events sent tempers flaring on both sides of the aisle.
Never one to miss an opportunity to chastise Republicans, President
Obama then held a carefully contrived Town Hall Meeting at the
University of Maryland.
Before a packed house of supporters, the President went off on
Republicans. In a fit of self-righteous indignation, Obama accused
Republicans of single-handedly pushing the country to the brink of doing
the unthinkable... defaulting on our debt.
Never mind the White House and Democrats haven't proposed a solution of
their own for resolving the debt ceiling crisis. That's right, the only
two solutions on the table right now were proposed by Republicans.
But hey, why propose a serious solution to a potentially catastrophic
problem when you can use the issue to smear your political opponents,
right Mr. President?
Things certainly looked bleak for the US on Friday night. However, all
is not lost. There's still time for both sides to reach a compromise by
the August 2nd deadline for raising the debt limit. (We have eight more
days after all!)
Unfortunately, with both sides digging in their heels, the likelihood of
the US defaulting on its debt has certainly increased. And the
heightened possibility of a default is sending shockwaves through the
markets.
This raises an important question for investors. What will happen to the
markets if the US does default?
The short answer is nobody really knows exactly how markets will react.
A default of this kind has never happened before in the US. However,
it's pretty clear how a default would generally impact various types of
investments.
First off, interest rates on US Treasury bonds would almost certainly
surge higher. This is not what the fragile US economic recovery needs
right now. Higher rates would raise everyone's cost of borrowing and
likely stifle economic growth.
You see, Treasury rates are used as a baseline for just about every kind
of interest rate. In other words, higher Treasury rates would make it
more expensive for ordinary Americans to take out a mortgage or get
financing for consumer purchases. And they would drive up the cost for
corporations to get loans needed to expand their businesses.
What's more, we'd likely see stocks, bonds, and the US Dollar plunge
in value. These types of investments don't perform well when investors
fear a major slowdown in economic growth. Investors tend to pull their
money out in times of crisis and move it into traditional safe-haven
investments.
What qualifies as a safe-haven investment?
The most popular one right now is Gold. Over the past several years,
Gold has been the safe-haven of choice in times of crisis. And recently
we've seen Gold surge to all time highs. With the other two usual
safe-havens - Treasuries and the Dollar - poised to plunge, Gold will
probably see even more crisis-buying than usual.
So, what should an investor do?
Let may say up front, I don't think it makes sense to liquidate your
stocks and bonds and move all in on Gold. While the prospect of a
default is frightening, I don't think it's going to happen.
Sure, we'll see some heightened volatility in the days ahead. But, in
the end, there's just too much at stake to allow a default to happen.
I'm confident our elected officials will find a solution... although we
may come down to the wire before an agreement is reached. Not because I
have faith in our public servants to do the right thing. No, there's a
better reason than the public good.
The fact is it's in every politician's best interest to avoid default. No matter how much they might bluster, the President and Congress both
know their political futures are toast if they allow the government to
default. And nothing drives a politician to act like fear of losing the
next election.
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