How Bad Would A Debt Default Really Be?

| October 16, 2013 | 0 Comments

Debt CeilingThe financial markets are waiting with bated breath as US politicians try to resolve the debt ceiling crisis with just a day to go before the limit is hit.  There’s basically no reason for me to talk about anything else right now because just about everything market related hinges on Washington.

It’s a sad state of affairs, but there’s not much we can do but wait (and buy VIX calls).

So what could be the possible effects of a US debt default?

Let’s look at some of the things we know are almost certainly going to happen should the US Treasury become unable to print money…

Most importantly, the US would not be able to pay many of its most basic obligations on time.  Things like Social Security, Medicare/Medicaid, unemployment, and even military pay would be delayed – sometimes significantly.

The delay or lack of payments is projected to knock a whopping 4.2% off GDP.  That would certainly plunge the country back into recession.

What’s more, even if the Treasury prioritizes interest payments, the turmoil and uncertainty will lower the US credit rating.  This means it will cost more for the country to borrow money – an extreme negative amplification when the economy would be headed back into recession.

Basically, consumers wouldn’t have money to spend and the government would get less bang for its buck.  The only other time a scenario like this happened… The Great Depression.

And that’s not all…

The US Dollar is the world’s premier store of value.  If it loses its appeal, trillions of dollars could literally exit government bonds, throwing the financial markets into absolute mayhem.  (Of course, stocks would also plummet, not just bonds.)

In some cases, other countries don’t have anywhere else to put their reserves (such as China).  Euro area bonds are not yet attractive enough due to the region’s recession.  And, Japan has its own volatility.

As such, global economies could see their reserves lose substantial value.  Along with less spending from the US (the world’s largest economy), it could cause the entire globe to fall into a prolonged recession.

And that’s just the stuff we know about!

Make no mistake, a debt default would lead to catastrophe if allowed to persist.  There’s just no way around it.  If you haven’t done so already, keep your fingers crossed that our barely-functional government can get its act together long enough to avert disaster.

(And once again, it’s not a bad time to buy some OTM VIX calls just in case.)

Yours in Profit,

Gordon Lewis

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Category: Breaking News

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.