Photo (cc) by Bods
If I wasn’t seeing it with my own eyes, I wouldn’t believe it.
Congress is once again using the debt ceiling as a negotiating chip in a game with the highest possible stakes — the world economy.
Raising the debt ceiling allows the government to borrow more money to pay for spending Congress has already approved. Not raising it ultimately means bills going unpaid. To understand the ramifications, see our recent post, “9 Things You Need to Know About the Debt Ceiling.” But in essence, without an increase, our nation will be unable to pay its bills, undermining both our credibility as a country and the worldwide financial system.
How does that translate to Main Street? In the worst-case scenario, a stock market crash and higher interest rates on everything from credit cards to mortgage loans. That in turn would slam the brakes on business, increase unemployment and potentially push our economy into recession.
While this is the scenario many envision, some disagree. In a USA Today article called “Debt Limit Breach No Big Deal, Some GOP Lawmakers Say,” U.S. Rep. Ted Yoho, R-Fla., said, “I think, personally, [reaching the debt limit] would bring stability to the world markets.”
Rep. David Schweikert, R-Ariz., said:
I will hear language like, “Well, we are heading toward the debt ceiling and you are going to default.” Anyone that says that is looking you in the eyes and lying to you, either that or they don’t own a calculator.
Financial calamity is typically something that happens suddenly, its causes only clear in the rear-view mirror of history. Not so with this potential nightmare: We can see it coming. So is there anything you can do to protect yourself? Let’s examine the options.
Option 1: Do nothing and hope cooler heads prevail
It’s important to distinguish between failing to raise the debt ceiling by the day it’s reached (estimated to be shortly after mid-month) and the United States actually defaulting on its obligations.
It’s not Armageddon if Congress misses the deadline by a few days, or possibly even a couple of weeks, especially if a compromise is clearly on the horizon. It’s when the U.S. actually fails to pay an interest payment on its debt or other bills that the financial world begins to unravel.
Many experts have argued that while the former scenario is possible, the latter is highly unlikely. One of many examples: Last week legendary investor Warren Buffett said on CNBC, “We will go right up to the point of extreme idiocy, but we won’t cross it.”
If you fear a financial meltdown, there are things you can do. (More on that in a moment.) But remember that although stupidity seems to be running amok these days, the U.S. has never defaulted on its debt. And while there may be some in Congress who think this would help their political careers or “bring stability to world markets,” they’re the exception, not the rule. Odds are that one side or the other will blink.
Option 2: Sell, sell, sell
In the commonly accepted scenario, a U.S. default would result in a collapse of both stock and bond prices, decimating many 401(k)’s and other investment accounts. To be on the safe side, you could get out of the way now by selling securities and holding cash until the crisis is resolved.
The problem with this approach: If you’re wrong, it’ll cost you.
The most likely scenario is a deal will be reached. When that happens, the stock and bond markets will probably celebrate by going higher. So while there’s risk in staying in the game, there’s also risk in remaining in the dugout.
Option 3: Don’t sell, but hedge your bets
“Hedging” refers to taking an investment position that will gain in value if your primary position goes bad.
For example, if you look at my online portfolio, you’ll note I currently have about $200,000 in stocks. But I also hold an investment in gold: SPDR Gold Shares. I don’t think gold is a great investment, but if something like a major war or debt default happens, my stocks will get crushed, but the gold would probably go up. Thus, gold is a hedge against my bet on stocks, which are a positive bet on the American economy.
There are numerous other ways you can hedge against a default, including raising cash, shorting U.S. Treasuries in the futures market or with ETFs, and moving out of small stocks to the biggest — thus safest — U.S. companies.
An investment hedge, however, can carry the same risk as insurance. If the disaster you’re insuring against doesn’t materialize, you’re out the premiums you’ve paid.
What I’m doing
When it comes to investing, I’m so boring, paint could watch me dry.
When you looked at my portfolio, you may have noticed the last stock I bought was Ford, back in 2011, and most of my portfolio was purchased in 2009. The market has had lots of scares since then, as well as ups and downs. So why don’t I buy and sell?
For the answer, look to one of the few stocks I did sell: Bank of America. I bought it in 2008 for $14. I sold it to take a tax loss in November 2011 for $5. My intention was to buy it back 30 days later; any sooner and the tax loss would have been disallowed. But did I? Nope. And now it’s back to $14.
The point is, I’m not smart enough to time the market. So unless something’s both catastrophic and certain, I’m unlikely to either sell, sell, sell or put on a substantial hedge. And while I do believe that a debt default would be catastrophic, so far it’s not certain.
So I’m not doing anything with my existing investments, at least not yet. Here’s what I am doing:
- Raising cash. Should the worst-case scenario occur, cash will be king. I’m keeping as much of it around as possible.
- Scouting potential investments. Thanks entirely to Congress, the market’s been falling daily. Soon there will be bargains. If we don’t default, I’m a buyer.
- Taking names. This article should never have had to be written. I won’t forget those in Congress who created a national crisis for their personal political power. I will do everything possible to see they’re gone at the earliest possible moment.