• 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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Fix It Now, Please!

There are a number of pertinent issues regarding the so called “fiscal cliff.” First of all it is not a cliff. What if the President and Democrat dominated Senate cannot come to terms with the Republican dominated House of Representatives? The effects will play out over several years. If the middle class tax cut is not extended, it will have a measurable effect on the economy, over a period of months and years. Likewise, if the tax cut for the highest US income earners is not extended it will also play out over months and years. The same applies to mandatory cut backs on military spending and social programs. A smart investor can manage his or her investment portfolio to accommodate any and all possibilities. However, a fiscal cliff fear factor, a fear of uncertainty and unnamed economic catastrophe, can drive the market and cause investors to make poor choices that will serve them badly in the long run. The better result for long term investors will be for the President and Congress work to an early solution so that the fiscal cliff fear factor can go away. Then the average investor can choose his or her stocks, invest for retirement, and collect on his dividend stocks without the gnawing sense of uncertainty that is the fiscal cliff fear factor.

And if the Problem Continues?

Let us assume that business as usual will continue in Washington. Republicans will probably dig in their heels. They will continue to work on their long term goal of rolling back the social programs of the Great Society of the 60’s and New Deal of the 30’s. Democrats will seek to preserve the same social programs while dealing with budget deficits, the likelihood of a steadily devaluating dollar, and the risk of losing the White House in 2016. The eternal cat fight on Capitol Hill never seems to serve the interests of the Nation but that is how it is. How can an investor benefit from the market chaos caused by the fiscal cliff fear factor? No matter how heated the arguments become there will eventually be a solution that preserves the US military, social programs, and reduces spending for both. Consumer products stocks are typically a good refuge in tough times. One might think that it is time to sell defense stocks, but the better choice may be to wait for market prices to fall and buy at bargain prices before a deal is made. This argument probably applies across the board. Let the fiscal cliff fear factor drive prices down and buy when prices bottom out. When the cat fight on Capitol Hill finally resolves itself, prices will likely go back up. As usual do your own fundamental analysis and look for a good margin of safety in the stocks that you buy.

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