What You Can Do to Protect Yourself Against a Totally Unnecessary U.S. Government Default

By Robert Engle and Andrew W. Lo

If Congress and the White House fail to raise the debt ceiling this week and the United States defaults on its debt, what can we expect and how can we protect ourselves against these events?

First of all, we might look at our savings and retirement funds to see if we own Treasury securities. If so, Treasuries will stop paying interest and decline in value, so it would make sense to sell them and replace them with AAA-rated corporate bonds.

Next we should look at our cash holdings, which probably are in some form of money market fund. This fund is likely to be heavily invested in U.S. Treasury bills and other U.S.-guaranteed agency debt. With a default, money market funds may not be able to pay redemptions and will be forced to “break the buck,” meaning their net asset value will fall below $1. The first investors out of these funds will be repaid in full, but later exits will not. So now is the time to move these funds into your banks’ checking accounts. If you thought it was hard to get an iPhone 5s, try getting access to your money when everyone else is trying to make their transfers.

But how safe are checking accounts? The FDIC guarantees these accounts, but as of December 2012, its Deposit Insurance Fund had only $65 billion, of which 53% was invested in U.S. Treasuries. As of August 2013, there was $1.4 trillion in checking accounts. Savvy investors will withdraw demand deposits too, recognizing that they can no longer be fully protected. The best place for your money probably is in cash, but do we really believe that paper money will be able to maintain its value? It’s guaranteed by the full faith and credit of the U.S. government, but how much is that worth today?

Maybe instead of cash we should buy stock in U.S. companies. But think about what happened to the U.S. stock market in 2008 when Lehman went under and the Reserve Fund broke the buck – the cumulative return of the S&P 500 from September 1 to November 31 was 29.6%. And this was in the good old days when the government wasn’t shut down and could still pass legislation.

During the financial crisis of 2007-2009, the U.S. government was able to calm this panic by guaranteeing all money market funds, injecting capital into the banks, recapitalizing the FDIC, and opening short-term lending windows at the Fed. However if the government has no borrowing capacity, it cannot do this again, even if it were open for business.

So maybe the best solution is to move to Canada to become a subsistence farmer before Thursday, taking all your belongings (including a big pile of gold, diamonds, or RMB) with you. Or you could write angry emails to the people responsible for this unprecedented, self-destructive, and completely unnecessary threat to global economic welfare.