The “common wisdom” going unchallenged by the media and those talking to the media is “If the US Government defaults, the Stock market will Crash!” The Sky is falling!
I don’t believe that to be true – in fact the opposite is extremely likely. There are two main reasons for that right off the top of my head
1) If the credit rating drops, it’s fairly likely that interest rates will zoom up – without borrowing authority at the Treasury, Bernanke can’t “soak up” all the “bad” US debt into the Federal Reserve System and hide it. When interest rates go up, the value of bonds goes down – a LOT (especially long term bonds). In order to not be clobbered by a loss in value in bond holdings, big investors will either unload their bond holdings or try to hedge their bond holdings with interest derivativee contracts like interest rate swaps. If they sell off their US Bonds, financial instutitions have to do something with the cash – FDIC doesn’t cover insurance company portfolios. They can’t just leave the money sitting in cash in a bank. One logical alternative would be to invest in high quality stocks or very high quality corporate bonds – or convert them into a more stable currently like the Swiss Franc
2) If the treasury defaults, the foreign exchange (FOREX) rates for the dollar will fall apart. As I’ve pointed out so many times I’m tired of saying it, whether the US Stock market goes up or down is almost entirely driven by FOREX rates. If the dollar gets worth less and falling, the price of stocks (not to be confused with the value of the stocks) goes up in the short term – people want to unload their dollars into something more substantial than dollars. Things like profits, unemployment rates, GDP growth take years to blend themselves into the value of the stock market.
Should the dollar plummet off the charts, that means anything we import will be very expensive suddenly – the biggest thing being gasoline and other oil related products. $10 a gallon for gasoline is not hard to imagine. The US Economy will grind to a halt! (right?). Not so fast.
While the costs of things we import will rise, the price of things we make will become unreasonably cheap to other countries. Canadians will be able to buy a brand new US made car for $10,000, Germans wanting to buy a condo in Florida will buy them up as fast as they can be made, food exports will flood places like China. People with big piles of dollars will want to turn them into something *real* as fast as they can.
The problem is that the United States would at least initially be hit with hyperinflation. The silver lining of that cloud is it solves the problem of upside down mortgages as real estate zooms up in price. Also, if Oil was suddenly $300 a barrel, you can’t begin to imagine how fast derricks will show up in Texas and North Dakota to start doing oil fracking and deep wells..
So don’t believe everything you hear on TV or from Barack Obama or John McCain. Economies are self-correcting if governments just resist the urge to steer them in a direction they don’t want to go. Once everyone unloads their dollars and Europe is in recession due to cheap US imports, the FOREX exchange rates will return back to the level they should be at now without the overmanagment being done by Tim Geithner and the Obama regime.
God save us from John McCain.
If only I had something worthwhile to add to this. Extremely interesting and thought provoking.
Just to blather on a bit longer – none of the above is saying that a default or credit downgrade won’t be devestating – just not the way the Blond babes of Fox and CNBC think.
Once people realize the FDIC does not have FF&C and has no money and no ability to borrow money from the Treasury. the bank runs start. At least one “Too Big to Fail” Bank will fail. European banks and anyone depending on IMF guarantees backed by the US Treasury will realize a “Back Stop” guarantee is nothing but a facade.
Hyperinflation wipes out everyone’s savings (if they’re in anything that is measured in dollars). Hyperinflation will trigger cost of living increases in Social Security, which will move it from “It has money for the next 24 years” to…. it’s going to be broke in 5 years.
It’s almost a guarantee that riots would break out in most cities with a large population dependent solely on those government checks and wealth transfers. When midnight comes and the Food Stamp debit cards don’t get refilled, and people are in line at WalMart and get declined, they won’t be happy puppies.