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Economic Impact of Debt Default

According to a study by the United States Treasury if the United States government does not raise the debt ceiling the economic impact of debt default will

  • be catastrophic,
  • will last for decades,
  • and will likely plunge the nation into a recession as bad as the Great Depression.

Despite the gravity of a potential debt default many find it impossible to believe that the members of Congress and the White House cannot come to some agreement that will avert such a disaster. For example, Warren Buffet is quoted as saying that the government will proceed to the point of extreme idiocy but not any farther. Since our job on this site is to look for profitable investing tips let us consider how an investor might approach this situation considering the terrible economic impact of debt default should that occur.

The Details

Economists are in agreement that the economic impact of debt default would include the following:

  • Higher interest rates
  • Hording of money and a lower rate of investment
  • Higher payment on US debt as investors demand more for their risk
  • Unemployment due to a contracting economy
  • Widespread layoffs immediately
  • Slower economic growth very likely another recession
  • All of which would likely last for a lifetime

Why Is This Happening?

A set of fundamental problems for the USA revolves around the cost of governing, the size of the national debt, the cost of servicing the national debt, the degree of intrusion of the US government into everyday life and decision making, and the increasing difficulty that the two political parties have dealing with each other in solving the issue of governance. A small group of Republican congressmen opposed the new health care bill, Obama Care. They appear to be willing to not only shut down the Federal Government which they have done but to throw the nation into default on its debts. Many believe that only such an extreme measure will result in a draw back on federal spending and the steadily accumulating federal debt. Thus there are otherwise rational politicians willing to endure the economic impact of debt default in order to remedy a long term issue of excessive government spending. Others would prefer a middle course in which default is averted and subsequent governance follows a more frugal path. Fundamental analysis for profitable investing on this issue is not difficult in that default will or will not happen and attention to the debt burden will or will not happen. Cautious investors may wish to purchase put options on certain stocks in order to protect against catastrophic loss in case of default and call options in anticipation a market surge when the issue is resolved.

Blood in the Streets Investing

The time honored quote from Baron Rothschild would seem to apply here, the best time to invest is when there is blood in the streets, especially your own. As the US Treasury has said, the economic impact of debt default would be catastrophic. Investing foreign stocks is probably not an answer as the US dollar is too central to global markets. Rather one needs to look at what stocks will weather the storm, wait until they are beaten down by the economic impact of debt default, and buy. Think of intrinsic stock value and a margin of safety when buying in a down market.

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