How could USA defaulting on its public debt influence the stock/bond market?
"This is a speculative question and there's no ""correct"" answer, but there are definitely some highly likely outcomes. Let's assume that the United States defaults on it's debt. It can be guaranteed that it will lose its AAA rating. Although we don't know what it will drop to, we know it WILL be AA or lower.  A triple-A rating implies that the issuer will never default, so it can offer lower rates since there is a guarantee of safety there.People will demand a higher yield for the lower perceived security, so treasury yield will go up.  The US dollar, or at least forex rates, will almost certainly fall. Since US treasuries will no longer be a safe haven, the dollar will no longer be the safe currency it once was, and so the dollar will fall. The US stock market (and international markets) will also have a strong fall because so many institutions, financial or otherwise, invest in treasuries so when treasuries tumble and the US loses triple-A, investments will be hurt and the tendency is for investors to overreact so it is almost guaranteed that the market will drop sharply. Financial stocks and companies that invest in treasuries will be hurt the most. A notable exception is nations themselves. For example, China holds over $1 trillion in treasuries and a US default will hurt their value, but the Yuan will also appreciate with respect to the dollar. Thus, other nations will benefit and be hurt from a US default. Now many people expect a double-dip recession - worse than the 08/09 crisis - if the US defaults. I count myself a member of this crowd. Nonetheless, we cannot say with certainty whether or not there will be another recession or even a depression - we can only say that a recession is a strong possibility. So basically, let's pray that Washington gets its act together and raises the ceiling, or else we're in for bad times. And lastly, a funny quote :) I could end the deficit in 5 minutes.   You just pass a law that says that   anytime there is a deficit of more   than 3% of GDP all sitting members of   congress are ineligible for   reelection.   - Warren Buffett" "The default scenario that we're talking about in the Summer of 2011 is a discretionary situation where the government refuses to borrow money over a certain level and thus becomes insolvent. That's an important distinction, because the US has the best credit in the world and still carries enormous borrowing power -- so much so that the massive increases in borrowing over the last decade of war and malaise have not affected the nation's ability to borrow additional money. From a personal finance point of view, my guess is that after the ""drop dead date"" disclosed by the Treasury, you'd have a period of chaos and increasing liquidity issues after government runs out of gimmicks like ""borrowing"" from various internal accounts and ""selling"" assets to government authorities.  I don't think the markets believe that the Democrats and Republicans are really willing to destroy the country. If they are, the market doesn't like surprises." Regarding the Summer of 2011 Crisis: There is NO reason that the United States cannot continue borrowing like it is just based on a particular ratio:  Debt to GDP. The Debt to GDP ratio right now is around 100%, or 1:1. This means the US GDP is around $14 Trillion and its debt is also around $14 trillion.  Other countries have higher debt:gdp ratios Japan - for instance - has a debt:gdp ratio of 220% Regarding a selloff of stocks, dollars and bonds: you have to realize that selling pressure on the dollar will make THE PRICE OF EVERYTHING increase. So commodities and stocks will skyrocket proportionally. The stockmarket can selloff faster than the dollar though. And both markets have circuit breakers that can attempt to curb quick selloffs. Effectiveness pending.
Typically the debt is held by individuals, corporations and investment funds, not by other countries. In cases where substantial amounts are held by other countries, those countries are typically not in debt themselves (e.g. China has huge holdings of US Treasuries). If the debts were all cancelled, then the holders of the debt (as listed above) would lose out badly and the knock-on effects on the economy would be substantial. Also, governments that default tend to find it harder to borrow money again in the future. Stocks, gold, commodities, and physical real estate will not be affected by currency changes, regardless of whether those changes are fast or slow.  All bonds except those that are indexed to inflation will be demolished by sudden, unexpected devaluation. Notice: The above is true if devaluation is the only thing going on but this will not be the case.  Unfortunately, if the currency devalued rapidly it would be because something else is happening in the economy or government.  How these asset values are affected by that other thing would depend on what the other thing is.  In other words, you must tell us what you think will cause devaluation, then we can guess how it might affect stock, real estate, and commodity prices. "The term ""stock"" here refers to a static number as contrasted to flows, e.g. population vs. population growth. Stock, in this context, is not at all related to an equity instrument.  Yes, annual refinance costs, interest rate payments etc. are what we should be looking at when assessing debt burden. Those are flows. That was my point when cautioning against naive debt GDP comparisons.  Also, keep in mind that by borrowing in it's sovereign currency, the US has an enormous amount of monetary tools to handle the debt if it ever became a problem. Greece, by comparison, is at the mercy of the ECB, so they only have fiscal levers to pull. The interest expense does not strike me as especially concerning, but I'd be happy to verify BIS or IMF reports if you would like." Just playing devil's advocate: A falling stock price impairs the firm's ability to raise equity capital efficiently. In these times, additional regulatory capital requirements continue to be levied on the banks, and they are faced with raising capital inefficiently, which may impair their ability to pay their debt, which may lead to a ratings downgrade. Many of the major indices retreated   today because of this news. Why? How   do the rising budget deficits and debt   relate to the stock markets? The major reason for the market retreating is the uncertainty regarding the US Dollar. If the US credit rating drops that will have an inflationary effect on the currency (as it will push up the cost of US Treasuries and reduce confidence in the USD). If this continues the loss of USD confidence could bring an end to the USD as the world's reserve currency which could also create inflation (as world banks could reduce their USD reserves). This can make US assets appear overvalued. Why is there such a large emphasis on   the S&P rating? S&P is a large trusted rating agency so the market will respond to their analysis much like how a bank would respond to any change in your rating by Transunion (Consumer Credit Bureau) Does this have any major implications   for the US stock markets today, in the   short term and in July? If you are a day-trader I'm sure it does. There will be minor fluctuations in the market as soon as news comes out (either of its extension or any expected delays in passing that extension). What happens when the debt ceiling is   reached? Since the US is in a deficit spending situation it needs to borrow more to satisfy its existing obligations (in short it pays its debt with more debt). As a result, if the debt ceiling isn't raised then eventually the US will be unable to pay its existing obligations. We would be in a default situation which could have devastating affects on the value of the USD. How hard the hit will depend on how long the default situation lasts (the longer we go without an increased ceiling after the exhaustion point the more we default on). In reality, Congress will approve a raise, but they will drag it out to the last possible minute. They want to appear as if they are against it, but they understand the catastrophic effects of not doing so. Like all many branches of the economy, they do cross over at points. Private stock value increases pushes up tax revenue which in turn contributes to easing of national debt. The level of economic ignorance in this thread is astounding. I imagine that it wouldn't affect consumer debt significantly. Individuals are separate entities from their government like how stockholders are separate entities from a corporation. It would probably make it harder for the country to raise money through bonds. Who wants to purchase bonds from a country that won't pay you back? It just occured to me that the larger the debt the easier it is for the Fed to strangle the economy, concentrate wealth even more, and choke off government spending on things other than debt service.  It is a huge problem that the US government appears to be in a permanent structural deficit that gets bigger both during expansions AND contractions. "So, I've read the article in question, ""Basically, It's Over"".  Here's my opinion: I respect Charlie Munger but I think his parable misses the mark.  If he's trying to convince the average person (or at least the average Slate-reading person) that America is overspending and headed for trouble, the parable could have been told better.  I wasn't sure how to follow some of the analogies he was making, and didn't experience the clear ""aha"" I was hoping for. Nevertheless, I agree with his point of view, which I see as:  In the long run, the United States is going to have serious difficulty in supporting its debt habit, energy consumption habit, and its currency. In terms of an investment strategy to protect oneself, here are some thoughts.  These don't constitute a complete strategy, but are some points to consider as part of an overall strategy: If the U.S. is going to continue amassing debt fast, it would stand to reason it will become a worse credit risk, requiring it to pay higher interest rates on its debt.  Long-term treasury bonds would decline as rates increase, and so wouldn't be a great place to be invested today. In order to pay the mounting debt and debt servicing costs, the U.S. will continue to run the printing presses, to inflate itself out of debt.  This increase in the money supply will put downward pressure on the U.S. dollar relative to the currencies of better-run economies.  U.S. cash and short-term treasuries might not be a great place to be invested today.  Hedge with inflation-indexed bonds (e.g. TIPS) or the bonds of stronger major economies – but diversify; don't just pick one. If you agree that energy prices are headed higher, especially relative to U.S. dollars, then a good sector to invest a portion of one's portfolio would be world energy producing companies.  (Send some of your money over to Canada, we have lots of oil and we're right next door :-) Anybody who has already been practicing broad, global diversification is already reasonably protected.  Clearly, ""diversification"" across just U.S. stocks and bonds is not enough. Finally: I don't underestimate the ability of the U.S. to get out of this rut.  U.S. history has impressed upon me (as a Canadian) two things in particular: it is highly capable of both innovating and of overcoming challenges.  I'm keeping a small part of my portfolio invested in strong U.S. companies that are proven innovators – not of the ""financial""-innovation variety – and with global reach." US bond traders have begun a new trading day looking at higher prices for Treasury paper while Wall Street is set to open lower. The mood swing comes as the head of China’s central bank has summoned the spectre of a Minsky Moment. Hyman Minsky is a economist famed for his theory about the risk of a sudden collapse in asset prices triggered by excessive debt or credit growth. The recent surge in global equity and credit markets has been accompanied by a number of strategists warning of a Minsky scenario and that chorus has elevated in tone by Zhou Xiaochuan, the PBOC governor.  He reportedly expressed concern that corporate and household debt are rising too quickly and said China need to defend itself from excessive optimism that could lead to a “Minsky Moment’’.  Stocks in Hong Kong closed down 1.9 per cent, its biggest fall in two months, led by property companies, while havens such as US government bonds gained. The 10-year Treasury note yield has dipped to 2.31 per cent, while gold has rebounded from early losses to rise 0.4 per cent. The yen, another haven barometer has appreciated 0.4 per cent in value versus the dollar. S&amp;P equity futures are now down 0.4 after the broad market closed at a record on Wednesday.  Ian Lyngen at BMO Capital Markets notes:  We’d be remiss in our assessment of the recent bid if we didn’t acknowledge that the initial downtrade in risk assets followed comments from PBOC governor Zhou citing the risk of a “Minsky Moment” for Chinese assets. This is the notion that exhausted gains in asset prices and credit growth lead to significant market collapses – also known as The Pessimists’ Delight. As today marks the 30th anniversary of the day that the Dow had its largest single-day selloff in history and Wednesday’s close above 23,000 set a new record of the index, Zhou’s comments seem very appropriately timed. If you are actually referring to all the political rhetoric and posturing over the debt ceiling issue.  That's a long ways from the US actually defaulting on paying debts.  A lot of government offices might shut down, but I expect anyone holding US debt to be paid off. (they have the printing presses after all)  If that's what you are referring to, based on the LAST time that the governement had to shut down because they didn't raise the debt ceiling, it won't be a big deal.  Last time, no debt was defaulted on, a bunch of the less essential government offices shut down for a few days, and the stock market did a collective 'meh' over the whole thing.  It was basically a non event.  I've no reason to expect it will be different this time.  (btw, where were all these republican budget cutters hiding when 10 years ago they started with a nearly balanced budget, and ended up blowing up the national debt by about 80% in 8 years time? (from roughly $6B to $11B)  I wish they'd been screaming about the debt as much then as they are now. Not that there isn't ample blame to go around, and both sides have not been spending in ways that make a drunken sailor look like the paragon of a fiscal conservative, but to hear nearly any of them tell it, their party had nothing to do with taking us from a balanced budget to the highest burn rate ever while they were in control (with a giant financial crisis through in as pure 'bonus') "Thanks for the article. A couple questions:  - Is your basic investment premise that as defaults rise, investors will demand higher rates, and thus loans will become more expensive for borrowers? Why can't the lenders include a larger reserve to offset defaults (making loans less profitable for them?), or why doesn't this just wipe out the riskiest tranches of abs? Does it have to result in an implosion in supply?  - ""Since 2009, car loans have exploded over $1.1 Trillion""- wouldn't car loans increase significantly from the bottom of the Great Recession as the economy recovered? Also, the graph shows the billions of car loans. I think you'd have to look at an inflation adjusted loan origination, as cars do not cost the same today as they did 1970, so, you'd expect the total dollar value of loans to be much higher.  - ""How many borrowers are using their cars as collateral for new debt?"" Are you asking how many are refinance their cars? I don't think this is a thing. Cars depreciate and most of the time, the value of the car is less than loan. People may be rolling over into a new car and loan but I don't think they are re-mortgaging their cars. I could be wrong but there has to be information available on this  - ""We do this through purchasing long dated 1-2 year out-of-the-money PUT options on first order stocks""- How do you know where the strike price on these stocks will be? If your very confident, you can sell a call above to offset the cost of the put. Or alternatively, why don't you buy a credit default swap on the abs tranches?" "When people (even people in the media) say: ""The stock market is up because of X"" or ""The stock market is down because of Y"", they are often engaging in what Nicolas Taleb calls the narrative falacy. They see the market has moved in one direction or another, they open their newspaper, pick a headline that provides a plausible reason for the market to move, and say: ""Oh, that is why the stock market is down"". Very rarely do statements like this actually come from research, asking people why they bought or sold that day. Sometimes they may be right, but it is usually just story telling. In terms of old fashioned logic this is called the ""post hoc, ergo proper hoc"" fallacy. Now all the points people have raised about the US deficit may be valid, and there are plenty of reasons for worrying about the future of the world economy, but they were all known before the S&P report, which didn't really provide the markets with much new information. Note also that the actual bond market didn't move much after hearing the same report, in fact the price of 10 year US Treasury bonds actually rose a tiny bit. Take these simple statements about what makes the market go up or down on any given day with several fistfuls of salt." I don't know Australian law, but I will give my US perspective here.  The custom in the US is for officers and directors to be indemnified by the corporation, and that LLCs have an even broader power to indemnify (even to remove the duty of loyalty!).  Moreover, directors will typically be able to purchase D&O insurance to protect them from loss in the event of liability. For US corporations (not LLCs), the duty of care (prudence) requires that directors behave responsibly in weighing major decisions, and consult experts and specialists before coming to rash decisions.  It usually becomes a court case in the context of a large public company in the midst of an acquisition event.  The only people with standing (in the US) are shareholders.  If all the other shareholders are directors, then it may be hard for them to blame you. Additionally, if you are concerned about the propriety of your actions, there may be sources to rely on.  First, discussion with your fellow directors can be a helpful guide (though will not usually immunize you from any accusation of wrongdoing), and disclosure tends to cure almost any accusation of breaching the duty of loyalty.  Second, boards often secure the advice of legal counsel, and sometimes bring on lawyers as members or will outright hire counsel for the board.  Third, there may be services that will provide you with generic advice (e.g. UK Companies House and US-based IOD), which might set you at ease a little bit. I don't know the details of Australian law, as I say.  But my sense of common law countries is that, like the US, they are primarily concerned about negligence (incompetently or imprudently neglecting to understand the business and make informed decisions), disloyalty (fraudulently engaging in self-interested transactions that either hurt the company or should have been offered to the company), and recklessness (not bothering to seek out information).  As long as you are active, informed, engaged, and not engaging in secret deals outside the company (especially deals where either side is competing with the company), then that would be more than sufficient under the US standard. If you are concerned about liability, then inquire into indemnifications by the company (in the US, the company can usually pay all legal costs of directors), insurance, and legal counsel.  I imagine your business partners are no more savvy than you are.  My impression is you are overreacting to relatively rare and exotic expression of corporate law (at least in the US). But I'll close by repeating that I don't know Australian corporate law. No. Busts are very infrequent, and if an equity were illiquid enough to be affected, the bust cost would be enormous. For a liquid equity, the amount of busted volume is insignificant except during a flash crash or flash spike.  Then it would be reasonable to redownload.