Last Updated Jul 13, 2011 9:51 PM EDT
What will happen if we default
As there is always the historically proven possibility that politicians will choose to put their own interests ahead of the public's, I believe that default is a real possibility. To get an idea of what might happen, I turn the clock back about three years, when Congress debated the $700 billion TARP emergency bailout.
On September 29, 2008, the US was dealing with a crisis that presented a real threat that our whole financial system might collapse. The TARP bill went to the House and was stunningly defeated. While the votes were being counted and revealing the outcome, the stock market reacted harshly by plunging more than nine percent on that day. A few days later, on October 3, 2008, Congress got its act together and passed the law by a large margin. Yet rather than recovering the earlier nine percent, the market declined further.
I suspect that history will repeat itself if we do default. The consequences of missing Social Security checks will be large enough that Congress will be forced to set partisanship aside, get its act together, and move at lightning speed. Checks will again go out and the US debt ceiling will be raised. This does not mean, however, that they will undo the damage they caused the nation. How much damage this might cause is really an unknown.
How investments will perform
Investors hate uncertainty, so a default will likely cause stocks to plunge. And since we have a global economy, this would include international stocks as well. They may or may not recover quickly. Though I can't say for certain, it seems logical that the failure of the US Treasury to make interest payments on its obligations would cause Treasuries to plunge. For the past couple of months, as the High Noon debt ceiling shootout has drawn closer, Treasuries have performed quite well. In times of uncertainty, investors typically turn to Treasuries. Gold, of course, is the other place investors turn to in panic. Curiously, gold is about where it was two months ago.
How to invest in the next couple of weeks
What I'm doing with my own investments is absolutely nothing. It's not that I have any confidence in our politicians to do the right thing by working together, it's more that I have confidence in capitalism being more powerful than partisan politics.
Investing is a long-term proposition and the more we speculate in the short-term, the lower our returns are likely to be. I personally don't believe we will be showing up at the supermarket to buy groceries with gold. Thus, I'm sticking with my balanced portfolio of mostly index funds and CDs.
My message to politicians
If the US Government were my client, I'd promptly fire them. But before I did that, I would sit them down for a serious talk with a Suze Orman/Dr. Phil sort of blend. I'd first tell them that the math is simple. Living within your means is critical to financial success, and that requires either increasing revenue or decreasing expenses, or a combination of both. I'd then tell them they were in desperate need of a marital-type therapist, since divorce isn't an option for a country like it is for a dysfunctional couple. I'd finally escort them out of my office, with the parting words: "Grow up. The time has come to stop doing your rendition of the 'War of the Roses,' and to stop playing chicken with the world economy for political gain. And, oh yes, don't let the door hit you on the way out!"
Note: image from investorcentric.blogs.nuwireinvestor.com.