US default as a risk to mitigate
Update: Thanks everyone for the continuing thought-provoking discussion. I intend to post my decision spreadsheet, and still am looking for suggestions on where to do so. It might come in handy come February. A discussion that I find interesting has branched off on the topic of technological progress versus Malthusian Crunch, and I started a new article on that over here.
I would like to kick off a discussion about optimal strategies to prepare for the event that the US government fails to raise the debt ceiling before the US Treasury Department’s “extraordinary measures” are exhausted, which is estimated to happen sometime between October 17th and mid-November.
This is a risk *caused* by politics, but my goal is to talk about bracing against the event itself if it happens, not the underlying politics. If you want to debate Obama-care, who is at fault, or how likely a US default actually is, please start a separate discussion.
I consider this to be an indirect existential risk because if it kicks off a national or global recession, it will likely slow or halt research and philanthropic efforts at mitigating longer-term existential risks.
Since there are obvious associations between unemployment/poverty and crime, civil unrest, and poor health, a global recession is likely to be to some extent a personal existential risk to those living in the United States or countries that have trade links with the United States.
I notice that the markets do not seem to be anticipating a bad outcome. But I heard one analyst advance the theory that investors simply don’t believe the government can (his words) “be that stupid”. I imagine there is more than a touch of availability bias as well—breaching the debt ceiling might, even for fund managers who harbor no illusions about the wisdom of politicians, be up there with science-fictional scenarios like asteroid impact, peak oil, grey goo, global warming, and terrorist attacks. Moreover, there may be a dangerous feedback loop as the politicians in turn watch the stock indexes and conclude that “the market says there is nothing to worry about”.
So, I would like to hear what folks who are making contingency plans are doing. Especially people who have training or experience in economics and finance. What do you think the closest parallels in 20th/21st century history are for what the worst case scenario for a US government default would be like? Is there anything you would have done differently if you had known the date for the start of the 2008 recession with a +/- 2 week confidence interval, starting in two days? Or, if you did call it ahead of time, what are you glad you did?
If the markets don’t seem to be anticipating a bad outcome but you do, buying options seems to be a straightfoward way to mitigate the risk that you face.
If you know any significant economic event happens buying options seems to be the right way to proceed.
I would however be very cautionus. There are people on Wallstreet who have significant inside information on what goes on in Washington. Effectively you are saying that you understand the city better then them. How likely do you think that’s true?
Good point. I don’t trust my meager finance skills to buy put options.
I was considering the less ambitious strategy of withdrawing whatever cash I have available in advance, defering discretionary purchases, and waiting it out. If there is a crash, I would thus avoid bank runs and would be able to use some of the cash to buy call options on some index-tracking ETFs. Or, you know, food and gas, depending on how bad it got.
I should really learn more about finance for next fiscal cliff.
I don’t think that learning more about finance will put you into a position to be as good as people with a lot of inside information about Washington at understanding it.
I would guess that most of the information that you have about the fiscal cliff comes from the media. You are competing against people who are much better informed than you.
The banks might be irrational because they suffer from availability bias, but what do you think do you know that they haven’t factored in their analysis that outweighs their huge information advantage of inside information?
Can you estimate the utility cost of that strategy if you prediction of a crash turns out wrong?
Perhaps, but I’d be wary about assuming that the average Wall Street figure with inside information on Washington is setting a good example for how to operate rationally on that information. The impression I get from the books I’ve read discussing the work of Wall Street insiders is that they are, on average, quite good at operating under “business as usual” conditions, but that those who are well calibrated for events outside of the norm are very much in the minority. Prior to the fact, we are probably not in a good position to identify who those well-calibrated people are.
This rings true, but I instinctively play devil’s advocate. You are essentially saying that the overall behavior of the market is driven by the decisions of a few insiders. The complementary scenario is that the market generally responds to widely available information, and that even though insiders can exploit this, there are not enough of them to actually drive the market. What observable features would you expect in a insider-dominated market versus an approximately-rational (boundedly-rational?) market?
Okay, some (anecdotal) evidence now in and it looks to be in support of… both models?
The insider-driven model you propose would predict that there would be a negligible reaction of the market to announcements of a deal trickling in this morning because the insiders would already know how it would go and would have traded accordingly. The non-insider-driven model would predict a rally after the deal was announced.
What we are seeing is W5000 (Wilshire 5000 index) closing last night at 18141, opening today at 18254, and rallying at just before 10am, when the first hints of the impending deal got on the news, to 18322 and staying roughly steady after that. S&P and NASDAQ behave similarly. So from last nights close to when this morning’s rally tapered off it gained 181 points. Of them, 113 were gained in after-hours trading, presumably by insiders. The other 68 were gained in trading during the 10 minutes after the news first broke. So, if we do a naive estimate, 68⁄181 = 38% of the movement it attributable to traders with access to the same information you and I have. So if I’m interpreting this correctly, and if this one datapoint is a representative one (two huge ifs) then insiders do drive stock prices, but the influence of non-insiders is not negligible. That in turn implies that it is not hopeless to turn a profit trading ETFs.
Again, all this is on one datapoint and should not be taken at all seriously, but this might be a framework for how to actually test the insider theory on a larger dataset.
Also, this may imply that the insiders (at least the ones whose actions are observable in this time interval) did not have more than about 18 or so hours notice.
If there is an even earlier group of insiders, the data (try zooming out) might be consistent with one or more of the following from there not being sharp rallies earlier:
There are too few of them to stand out over the noise of the non-insiders
They did not get their insider information at the same time and no individual one of them was large or greedy enough to trigger a rally.
They had automated orders that would be triggered only under certain conditions.
I think Goldman Sachs has both a lot of financial capital and good beltway inside information. The same goes for the other big banks.
I thought of one.
An insider-driven market anticipates legislation with major economic implications. A non-insider-driven market reacts to legislation with major economic implications. So if we see how the market acted during previous hotly contested congressional decisions, we should be able to infer if and to what extent it is insider-driven, and maybe even get some clues about what sectors most insiders are in, and what branches of government are feeding them information.
Curious what you think of this post on discourse.net.
Inconvenience. Risk of being robbed. That’s all I can really think of. Why, am I overlooking something obvious?
Can you put a number on it? How much money would that kind of inconvenience be worth?
Maybe $50 tops?
Update. For a more ambitious strategy of storing purchasing power as silver bullion, it works out like this:
Spot price as of now, about $21.21
Spread: about $2.25
So if I bought for $21.21 + half the spread, I’d pay 22.36/oz, and sell (in the event of no default) for 20.11, so about a 10% loss on whatever I invested. Probably more, given the small volume I’d probably be buying. On the other hand, I’d need that 10% a lot less in the absence of a default than I would need the inflated purchasing power of that silver if a default did happen.
If you hold fixed-rate debt (ie, mortgaged house), hedging against inflation is overkill. Just enjoy paying off your mortgage with inflated dollars.
Only if I’m still employed and the checks I get still clear.
Moreover, we’re talking about a worst case scenario. There can be no overkill. I have to take every opportunity and exploit it to create greater opportunities until those I am responsible for are no longer in immediate danger (or at least the greatest risk to them again becomes old age, at which point my efforts no longer need to be split between the two problems).
So if I end up with surplus buying power, I should find something to invest in. I keep reminding myself that a recession can also be a great buying opportunity if you can manage it.
Another low probability risk would be a house fire, though a fireproof safe might be a good idea.
It is probably worthwhile to go through the list of sovereign defaults and see which ones appear to be similar and which individual risk mitigation measures were successful in retrospect.
I called the 2008 US recession. Fortunately I was too lazy/risk-averse to do anything about it, as my plan was to move assets into Euros.
This one is actually rather fundamental to this subject. Deciding whether, to what degree and in what manner to hedge against a risk depends rather heavily on how likely that risk is.
I guess a thoughtful examination of probability is on topic.
What I wanted to avoid are smug dismissals of probability of default being so close to zero that it isn’t worth worrying about.
Small risk, large consequences, half the probability density on the next thirty or so days, the rest smeared across at least a year (short-term debt-ceiling increases with a replay of the standoff every few months).
Too late to fundamentally restructure my finances, at the moment I’m looking at simply having some liquid cash and stocking up on store-able goods ahead of time on credit so I can make payments for them with devalued future dollars if a default happens or pay them off immediately if it doesn’t.
That a strange way to look at things. MIRI won’t research FAI any slower through the federal funds shutdown. On the other hand military reserarchers who develop AI might be slowed down.
When it comes to research that poses an existential risk through nanotech, similar things are true. Government research produces a lot more existential risk than it solves.
Presumably you have some data to back this up?
What existential risks do the NIH, NASA, and CDC produce?
Lowtech Amish aren’t engaging in activities that produce much existential risk. Most of the existential risk we face come as a result of technological progress.
When it comes to building nanobots, I think that something in which NASA is interested.
Various NIH projects are aimed at advancing bioengieering. If someone solve protein folding simulation it’s possible that he can build a nanobot with it.
Various NIH research also makes it cheaper for people to machine for gene synthesis and build organisms that do have the possibility to mess up ecosystems.
The antrax attacks in the US were due to antrax from a US government lab. The CDC still has smallpox sample that it doesn’t destroy.
But pointing to concret risks isn’t the point. Breakthrough research tends to bring up things that you don’t forcast.
...including forecasting whether it will occur in a corporate, charity, or government funded lab?
I don’t think it makes sense to separate those two much. An advance in a government funded lab can lead to the idea being applied in corporate labs.
Okay, so we agree then? An across-the-board cut to federally funded research is not desirable?
On average I would expect application of research result raise existential risk, so no we don’t agree there.
I haven’t used the word desirable in this discussion at all. It’s besides the point if you want to speak about the effects that things that you can’t control have. It leads to a mindkilled arguments as soldiers mentality.
Good point—I had started this discussion to explore personal/local preparedness strategies, and the effect the same crisis might have on NIH or on MIRI is indeed off-topic.
That rush of confidence and almost righteousness you had when you posted that? No offense, but learn to recognize that feeling, it’s oversimplification or maybe wishful thinking.
MIRI depends on private donations. Private donors need to make money in order to donate it. MIRI depends on the power grid, sewer lines, police to deter street crime, and access to its FDIC-insured bank account. MIRI does business with various other businesses some of which depend on government contracts to remain in business, and all of which are also embedded in an enormously complex web of private and government entities. Individual members of MIRI are also part of this web, and if they can’t buy groceries or pay the rent, they will either a) stop showing up for work so they can deal with their immediate problems or b) continue showing up for work, let their stuff get repossessed, and then either b.1) become a burden on someone else (maybe MIRI while its liquid assets last) or b.2) starve.
I don’t want this situation to be true any more than you do. I find it abhorrently bad design. But none of that changes that it is true, and denying it amounts to contributing to the problem by refusing to consider how one can insulate oneself and what one cares about from it.
Your comment would be better without the first paragraph.
You are not a Legilimens; please do not pretend that you know what other people are feeling. It’s both epistemically and conversationally rude.
“please do not pretend that you know what other people are feeling” should be emblazoned in giant glowing text above every internet forum.
Is this a thing any human can really do? I mean, we evolved to quickly recognize emotions in others.
I agree that in the context of an Internet discussion, the sensorial bandwith is so low that miscalibration is frequent, and so we should strive to achieve “non empathy”. We have though a whole section of our brain devoted just to that, so I guess that this particular bias is hopeless.
You can certainly use the part of the ‘empathy’ modelling capacity to realise that telling other people what they feel tends to piss people off when you are wrong (and sometimes also when you are right). Failing to adequately account for such likely reactions isn’t an inevitability, it is a social skills failure and a fairly blatant one at that.
Most people learn not to do this after embarassing themselves a couple of times when it backfires. (An except is when attempting to deliberately provoke or one-up another (“U mad bro?”)).
That’s not what I was noticing: telling other people how they feel might surely be a social failure, but not pretending to know how they feel? That seems much harder, since we have evolved to base our social interactions on the ability to guess the emotions of the other members of the pack.
We also evolved the capacity to suspect that a thought we have might be wrong, and to develop notions of confidence.
Don’t strive for ‘non empathy’. Strive for ‘not being overconfident’. Also, keep in mind Scalzi’s maxim, “The failure mode of clever is asshole”
Also keep in mind Voltaire’s maxim, “A witty saying proves nothing”. ;)
Did it look like I was trying to prove something with that? Once you’ve seen it, you can judge it for yourself.
The proposed scenario was “prolonged recession with severe government austerity”, not “zombie apocalypse”.
To a first approximation, I suspect that a lot of the boring existential risks that don’t involve things that tile the universe with stuff look pretty much the same by the time they roll around to the place you live: Democratic Republic of the Congo
Oh, yeah, sorry, I forgot to make the connection back to non-boring existential threats:
To a first approximation, I suspect that a lot of the boring existential risks that don’t involve things that tile the universe with stuff look pretty much the same by the time they roll around to the place you live: Democratic Republic of the Congo and people get so preoccupied with not starving that they lose interest in friendly AI and rationality except in its most instrumental applications.
The rush of adrenalin and almost righteousness I had when I posted the above response? I really need to recognize that feeling, it’s called being pissed off at a mental model I have of a certain world view from which I would expect a response similar to the parent post.
ChrisitanKI, I am sorry. Your later posts show that you are seriously addressing the topic and are not the straw-man I was attacking. Also, you at no point said “this does not affect MIRI so it’s not a problem”. You were only rebutting my assertion that a treasury default is an existential risk. I should have responded strictly to that instead of getting personal.
Thank you to MrMind for saying:
and to wedrifid for saying:
This was what I needed, apparently, to come around.
There not much emotion in the lines I wrote. You are the person who’s emotional because of some perceived danger to yourself.
There no wishful thinking behind the notion that a lot of scientific research is dangerous. I’m in favor of scientific research because without it I will certainly die in the next hundred years. On the other hand the idea that scientific research reduces existential is naive.
Yudkowsky was working on building AGI when he got the insight that the likely outcome of building an AGI is that the AGI goes bad and kills everyone. Then he grew up and thought about whether persuing that problem is the right thing to do.
There are way to many scientists who just naively want to believe that they are doing good, when they are endangering humanity. The idea that everyone is on the same time when it comes to reducing X-risks is wishful thinking.
Bottom line, MIRI and similar projects only exist in countries rich enough to have the time and resources to devote to future risks. If you believe that MIRI reduces existential risks, then something that is a risk to MIRI is itself an existential risk to some extent.
If there no one rich enough to engage in AGI research, you don’t need MIRI to prevent existential risk.
Doesn’t this extend to a generalized argument against technological advancement, since any of it might cause existential risks?
Not necessarily. Couldn’t one argue that technological advancement is neutral? It’d be hard for farmers to detect and blow up incoming asteroids, for example.
Don’t think “neutral” is the right word, it’s more like technological progress has two consequences pushing in different directions. On the one hand, tech makes humanity better equipped to deal with existential risk that is there regardless (e.g. asteroids). On the other hand, tech creates new kinds of existential risk (e.g. grey goo). Which effect is stronger/more important is debatable.
Yes, it does. If the main thing you care about is existential risk than getting rid of all technological advancement is benefitial.
The average technological advance raises existential risk. Pushing technology for it’s own sake in the hope that it solve existential risk doesn’t make sense.
Do you mean at the current level of technology or do you mean at all times everywhere?
For example our ancestors were nearly wiped out by an ice age...
I think if I sample technology the average technology got developed in the 20st or 21st century.
Which ice age do you mean? The last one? What evidence do you have for that claim?
See e.g. this or this.
I believe the most likely existential risk is a Malthusian Crunch.
Unlike many of the optimistic transhumanists out there, I believe that we are in a constant race between technology opening up new resources (or more efficient use of existing ones) and runaway population growth (which contributes to an astonishing array of seemingly unrelated world problems). Whenever technology starts to lose you have overshoot followed by civilizational collapse.
We have only a limited number of such collapse cycles before we exhaust whatever the rate limiting resources turn out to be and permanently foreclose on expanding beyond Earth and having any sort of shot at being the species that beats The Great Filter.
Moreover, a collapse happening pretty much guarantees that anybody who is cryosuspended before that time will permanently and irrevokably die with no hope of reprieve.
Empirically, in reality, there is no runaway population growth.
Empirically, what level of population growth would it take for you to consider it runaway?
Population growth rates are not steady-state. They are a function of many things, notably the prevalent wealth and education (which tend to go together) in a society. So far all human societies which reached a certain level of wealth sharply curtailed their growth rates and in many cases actually sent them into negatives.
...and this wealth is possible because of technological growth. We might make the world wealthy enough fast enough to bring population far enough down to be sustainable, but it still amounts to a race between technology and population growth, which was my original point: invent or die
Your original point was that each technological advance enables another jump in the population.
My point is that in reality this does not happen: a certain level of technology/wealth/education (already attained in large parts of the world) stops population growing. It does not enable further expansion.
Where did I say that?
Here is my actual original point.
Well, we better hope that this trend causes the population to level off fast enough to avoid overshoot. Maybe we should be just a little bit curious about how likely that is. And we should remember to offset the population growth slowing with the fact that per-capita resource demand increases.
Let’s continue this thread here please.
Population growth is primarily a problem in Africa. With present technology it can mean genocide in Africa. Civilizational collapse in Africa is a humanitarian tradgedy but it shouldn’t bring down Europe, the Americas or China.
Or, a briefer version of the below:
Europe, the Americas, and China are all part of the same global economy. They bid for the same collection of fixed resources and space. They share the same commons and the same tragedy of the commons. It’s the same way that just because you’re not directly linked to the government doesn’t mean that you won’t be affected by it collapsing, but on a global scale.
Okay, so I’ll try to learn from recent previous experience and not flame.
Deep breath.
Very partial list of how population growth can bring down Europe, the Americas, China, and everyplace else:
Waves of refugees straining the local infrastructure past the breaking point.
Demand for petroleum rising faster than the rate of new oil reserves being discovered and faster than alternative technologies can be developed and brought to market on a sufficient scale.
Ditto for accessible deposits of some metals.
Pollution.
Pandemics spreading from regions of high population density to everywhere.
Deforestation.
Global warming and sea level rise.
Competition for resources leading to wars.
Environmentalists like to view this as our species being irresponsible. They’re not seeing the big picture. At any given level of resources and technology, there is a finite carrying capacity. If we exceed that carrying capacity, we will have a die-off soon after no matter how “responsible” we are. If there were only a few million of us on the planet we could spend our days hunting endangered species from 1 mile-per-gallon SUVs that run on coal and melted plastic and still be okay.
It’s not easy to migrate away from Africa and it’s a matter of political willingness to accept “waves of refugees”. The highest demand of petroleum and metals doesn’t come from those place with high population growth. A US citizen consumes ten times the amount of energy as a nigerian. And Nigeria is a country that uses a lot of energy for an African nation because it has oil.
A Amercian house cat consumes produces more CO_2 than some Africans.
There no reason that everyone has to die.
But in reflection I grant you that developing alternative energy technology might reduce some risks.
But being responsible can mean using only a tenth as much energy which means you could have ten times as many people.
When it comes to the issue of overpopulation we face the trend that birth rates go down. The problem moves in the right direction. As far as current trends go it’s unlikely that population will double.
Well, it’s happening in Europe already. The US is having immigration issues of its own as well.
As I said to Lumifer, birth rates are going down because of wealth, which is driven by technology. As you pointed out, though:
...wealth is also accompanied by increased resource demand which may cancel out the time that diminished population growth buys us.
By the way, the emphasis on Africa is misplaced. It might, as a continent, have the highest growth rates, but most populated countries are outside of Africa, and most of them have grown by more than 20% between 1990 and 2010.
That’s all pretty standard scaremongering that has been making the rounds since early 1970s. There were no signs it’s likely to happen then and there are no signs it’s likely to happen now.
What would be the signs that we would be observing if it were likely to happen?
A large stable trend of rising resource and energy scarcity (and consequently their prices) across most resources and kinds of energy. Scarcity growing fast enough so that it’s unreasonable to expect that technology will compensate for that.
Here then.
Granted, these are from biased sources, because most sources are biased. But we must balance that against our own confirmation bias. I don’t have to agree with them on their proposed solutions in order to recognize that there is a credible problem.
I think it would be very worthwhile to think about what exactly would be a reasonable rate at which we can expect technology to compensate. That’s what I’m trying to say—not that the scaremongers are right, but that we don’t have good estimates for demand growth versus technological growth. Actually we have excellent estimates for demand growth, it’s the compensating technological growth rates that are problematic to accurately forecast. If we can’t reliably forecast them, I submit that the safe course of action is to pour resources into many different types of basic and applied research instead believing that the current rate of progress will suffice with absolutely no evidence (other than “been okay so far”) to back it up.
Let’s continue this discussion here please.
Aha, finally found a replacement for InTrade for calibrating predictions of US economic/political events.
https://www.ipredict.co.nz/app.php?do=browse&cat=1112
I poked around that site previously, but it didn’t seem to say anywhere whether US citizens were allowed to bet on it. Do you know?
Haven’t tried signing up yet.
I never bet on Intrade anyway. I just looked there now and then to see how people who are more confident then me were betting.
There is no real short-term crisis. As an economist I think that the big risk is that U.S. government spending continues to greatly increase but long term growth rates stay low and in 20-30 years the U.S. faces a political crisis over not being able to fund promised retirement benefits for the elderly, and responds by significantly increasing tax rates which causes negative economic growth.
Yes.
Yes, but in that case we’ll have huge problems much earlier than in 20-30 years. Japan’s situation is pretty unique to Japan and I don’t think US will be able to emulate it well.
I don’t think a meltdown is inevitable as long as the Feds stop digging at some point. So far they’ve shown no signs of being able to do that.
So, even if a frank default happens later this month you predict only a modest recession?
If by default you mean that the U.S. doesn’t pay T-bond holders, I would put the probably of this happening at below 10%. If it does happen it would have, to a first approximation, zero effect on the economy since everyone would anticipate that bond holders would eventually be fully compensated with interest.
I thought it’s an all-or-nothing deal—either they can pay all their debts or they cannot pay any of them. That there is no law putting priority one class of creditors over another, unlike a corporation where bond holders are paid first.
How would the market’s anticipation of T-bond holders not being paid look, and at what point would it begin? Is the market currently showing signs of anticipating a delay in payments to bond-holders? How would we expect the market to react if its anticipations are miscalibrated?
For the U.S. federal government revenues greatly exceed interest on all debts, even with no additional borrowing. I’ve never heard of the “all-or-nothing deal” theory before.
Given how much money is at stake, and the depth of the financial market for T-bonds, and the fact that it is legal for congressional staffers to engage in insider trading, I’m sure that anticipations on this are very well calibrated.
I guess I meant, the treasury has no legal authority to decide which obligations are paid and which aren’t.
http://www.businessinsider.com/can-the-treasury-prioritize-payments-if-the-debt-ceiling-is-breached-2013-10
Ah, now that would be useful information. Do you know if congressional staffers have to file some sort of disclosures when they make trades? If there’s a site where such disclosures are published, that might be what’s needed to infer what mix of actual and fake insanity we’re dealing with here, and which way they’re expecting things to go.
Part of the way they get paid is by providing info to hedge funds and then getting high paying jobs after they leave Congress with the hedge funds.
Whew! It’s over until February, and then we begin again.
I constructed a decision tree for whether or not to buy silver bullion, and sometime in the next few days I hope to clean it up and post it someplace for people to play with it and input their own estimates.
Can the Wiki handle XLS documents? Or is there some file repository that LW posts customarily link to?
Just the fact that people are now talking about the need to mitigate the risk of US default means that Treasuries are losing their status as the benchmark for the risk-free rate. Too late, too late...
If I were a rating agency, I would have bumped the US down more than one notch the last time this was threatened. The mere fact that we could talk about it with a straight face should have been very worrisome.
Well, S&P downgraded US debt the last time we went around that mulberry bush.
Bad things happened to S&P (and its owner McGraw Hill) after that.
Pointing out that the emperor is naked can be really bad for your health.
As a general rule, holding dollar-denominated fixed rate debt is a great way to mitigate inflationary risks. Best source of that is a mortgage on real estate.
It will suck to be a bondholder or on a fixed income. It will suck to buy things from outside the US. It will suck to have a long commute or to travel lots (gas prices). Stocks will hurt, but not too bad. Real estate is solid. Fixed rate debt holders are laughing as the banks have to accept their wheelbarrow dollars.
If you mean the risk is that US will not pay out US treasury bonds then the obvious hedge is to short sell US treasury bonds.
Heee-yal no!
Just because I disagree with the conventional wisdom that the US is too big to fail doesn’t mean I actually believe that’s a high probability.
I’m looking for strategies that are only slightly costly in the likely event of an 11th hour deal, but highly beneficial in the unlikely event of a default.
Hedge or don’t hedge. Hedge a little or a lot. But if you want to hedge but have a “Heee-yal no!” response to the simplest hedging strategy suggests some inconsistency somewhere.
Again, to the extent that you believe that the risk is a small chance of not paying out US treasury bonds then the obvious hedge is to short sell said asset. You want it to be only slightly costly, which places limits on how much hedging you can do via this (or any other) method. Since the market value of US treasury bonds cannot increase significantly without becoming mathematically absurd this is not a risky move.
You can likely optimise beyond this approach but if the strategy seems drastically aversive rather than potentially inefficient then something is broken.
I must admit, I don’t really understand bond pricing (which by itself probably means I’m not ready to be shorting them). I wouldn’t short a stock unless I was very confident it would go down, because if I’m wrong there is no theoretical limit on my losses, unlike being wrong about a long position. If a default is averted, there could be a market rally, and people shorting index ETFs would get screwed for example. Does it work differently for bonds?
Notice that the thing you need to be very confident about is that it will not go up dramatically. Having a high probability of staying stable or only raising by a small amount isn’t a problem.
Assume at some point you have reason to believe that you have information that the market does not and which creates a moderately small possibility of a stock dropping value dramatically. Also assume that you have a limited tolerance for risk. ie. You’re willing to invest $10k based on the expected value calculation but would accept no chance of losing more than that. In that case you can short sell the stock and also buy call options at a higher valuation (or just use a ‘stop order’). That way you gain when the price drops and lose when the price rises but the losses are limited to a predetermined maximum. You can then crudely visualise the payoffs as just similar to betting on a horse you think will win. You will probably lose a small predetermined amount but if the horse wins you win a lot.
There isn’t a difference in how shorting works. There is a difference in what bonds and stocks are. Stocks are based on the value of a company, which can obviously go through the roof. A bond is a promise to pay a fixed amount of money over a specified time. The monetary value of an IOU for $10 + $1 interest paid over a week is never going to be greater than $11 now, that’d be really weird. Bonds can lose all their value catastrophically if the issuer loses credibility but they can never gain value above “Bond with the specified terms assuming unquestioned reliability of issuer”.
...so there is a limited downside risk unlike shorting stocks?
And the upside is still (theoretically) the full price at the time you short it because it could in principle drop to zero if the debtor defaults? Is that correct?
Correct on both counts.
That’s what options are for, no? Buy a bunch of put options for US treasuries. Whatever you paid for the options is “wasted”, but you profit if they go down (in proportion to how much they fall by), and lose nothing more if they go up.
Cans of beans and ammo.
I’m guided by Popehat’s Clark—here, here, here, etc.
On a bit more serious note, how do you imagine default? What exactly, in technical detail, do you think will happen?
Beans, check.
Ammo, check.
Good to have around in general principle regardless of how the economy is doing at the moment. Store well, have intrinsic value, and are small enough to barter. I think of societal collapse as happening in stages:
Market infrastructure (banks, stock exchanges) still hobbling along in the midst of deep recession. Good time to have metals, short/liquidate stocks.
Market infrastructure crumbles. People starting to use precious metals. Good time to convert surplus precious metals into portable objects that are intrinsically useful and easy to trade. Or real estate if you can swing it.
Collapse of distribution networks means that certain goods are unavailable at any price in certain areas. Good time to already be stocked up on those goods, and ready to barter them, to expand purchasing power.
Find other people sympathetic to restoration. Use their help and whatever resources you’ve managed to secure in the previous steps to get the civilization ball rolling again.
...have you been around (as an intertubes-reading creature) in 1999? Beans and ammo were REALLY popular then. Among a certain kind of crowd, that is.
Sure. Beans and ammo were really popular among IT dudes like me who understood the kind of shit-storm that was brewing and was narrowly averted. Silver dollars were also popular, and I still have mine stacked up somewhere.
Now it’s vanished down the memory hole except for occasional cameo appearances as an example of why you shouldn’t pay attention to alarmists.
I drew a different lesson from the experience: not all dire predictions are self-fulfilling. Some are self-negating, and they look exactly like that one. I fondly hope all today’s doomsday alarmism also turns out to be this “unfounded”.
That’s the trillion dollar question.
What bothers me is nobody is willing to even hypothesize. That’s what screams availability bias to me: we don’t know what will happen, so we’ll just assume it either won’t happen or it will be business as usual.
I don’t even know what field (failure-ology? domino-tics?) I need to read in to actually make an informed guess, but the best guess with what little I do know (for a worst case scenario) is the following, in roughly chronological order:
Massive stock market crash
One or more ratings agencies downgrade the US from its AA rating.
Value of the dollar plummets, inflation ($100 is barely enough for even a cheap meal)
Run on the banks. The FDIC theoretically can still bail out failing banks by taking money from non-failing ones but who knows where there is a tipping point before they all fail (and presumably are all taken over by the FDIC). Even if they eventually manage to reopen them all, days or weeks pass before some people can access their accounts.
Government starts bouncing checks to employees, contractors, veterans, social security recipients, etc. They, along with thousands of people who never realized they depended on something that depended on regular checks from the government, are now overdue on their rent/mortgage/bills.
Some employees continue working for IOUs, some stay home, hard to predict which federal services are operating where. State and local services still mostly functioning.
Massive wave of seizures and foreclosures by creditors who are themselves in a desperate financial crunch. At this point, it no longer matters whether or not the debt ceiling is raised, the chain reaction has started.
Bouncing checks and repos trigger riots and in the chaos various ethnic/political/religious grudges also get rekindled. Again, some areas hit harder than others. Probably not a good time to live in an urban slum.
With police over-extended, increase in violent crime and property crime.
With the dollar’s lower purchasing power, it’s even more expensive to import oil, which has a further inflationary effect on almost every consumer good sold in the US. Food is particularly hit because fertilizers are made with petrochemicals.
Economies of various other nations collapse, with similar results.
...and I don’t know what happens next. Presumably at some point someone puts a bullet through your head and takes whatever you have left that’s worth stealing. Alcor can’t help you because they can’t afford liquid nitrogen, nor the cost of transporting your remains to Arizona in the first place. The end.
Total time scale: about a year. Hopefully I’m wrong and hopefully other posters and point out where.
The TEOTWAWKI scenario doesn’t look likely. Do note two things:
The Treasury isn’t prohibited from spending money or paying back the debt. It’s prohibited from borrowing more. Effectively that’s the same thing as saying that the Federal governement will have to run a balanced budget starting right now.
The Fed. The Fed can do whatever it wants and guess what it can do—it can print money! Moreover, it can print money and give it to anyone it likes, for example banks (threatened by bank runs) or, probably, even the Treasury.
seizures and forclosures are inconsistent with cheap meals costing a hundred dollars due to inflation. It’s one or the other—either there’s not enough money getting pushed to debtors, or there’s a surplus of money and debtors can pay their mortgage easily with inflationdollars.
There are two different mechanisms at work here. The inflation is due to a devalued dollar. The foreclosures are because you lose your job as a direct or indirect consequence of the recession.
If a cheap meal costs $100 instead of $5, then your $100k mortgage is backing a $2mil house, and you can borrow against your instant equity (even with no income or job).
The interest rates may suck on borrowing against your home equity, but it’s better than losing your house.
There more I think about this affair the stranger it becomes.
You have people discussing about raising the debt limit but nobody seems to propose simply getting rid of the debt limit. If people really think that the debt limit crisis is that bad, why don’t they propose to get rid of the concept of the debt limit?
A few ago there was the discussion about coining a 1 trillion dollar coin. Again if the debt limit crisis is that bad, why doesn’t the president coin the coin and get done with it?
If powerful people would really think that this is really bad, I would expect those two things to happen. What we are seeing is that Democracts want to argue that the Republicans are destroying the country. Some Republican seem to hope to get reduce Obamacare.
The NSA is probably happy that there a crisis that takes the public attention away from them. After all claiming that the Syrian government used chemical weapons only dominated the headlines for a short amount of time and there are still a bunch of unpublished documents.
The press profits from having news that interests their audience. It draws people in to get the latest news.
All those people who want to reign in federal spending have their field day, because the affair “proves” that it’s important to reign in spending and that overspending is a “serious problem”.
I makes it easier to corrupt all sorts of bureaucrats that now find themselves unexpectedly without a paycheck.
I wonder, next time control of the House changes, maybe they will try to do away with the debt ceiling. It’s a fairly recent problem. I think getting rid of the debt ceiling without replacing it with some more effective limit on deficit spending would be dangerous, though. I suspect there would be enough Representatives left in the House who felt the same way that such a bill would not pass.
The president actually talked about the use of legal exploits in a speech he recently gave (he didn’t talk about the trillion dollar coin specifically, but it would fall into the category he was addressing). He basically said that he “had plans” but they would face vigorous legal challenges, and would have almost as negative an impact as an actual default.
No, the same thing happened 17 years ago. There was even a time during the Bush government when Democrats didn’t want to raise the debt limit and used it for political leverage.
This also suggests that everyone in the press follows the playbook of the president and doesn’t get the idea of pushing the coin or a repeal of the debt deiling themselves.
So basically he said that he’s doing all he can and that the Republicans are still really evil.
If you think that the debt limit is an important concept for limiting deficit spending, why do you think that it should always be increased?
Also, why aren’t congressional budgets the tool of choice?
Because it’s a redundant constraint. The budget already limits the debt, and that is the best mechanism for limiting it—it can actually take effect safely. The debt limit is a guillotine. If it ever does anything directly, we are screwed.
It’s not a constraint—it’s a precommitment / beeminder-like device. It’s purpose (at least nowadays) is to make borrowing more politically painful.
Then why shouldn’t we get rid of the guillotine?
A few posts up:
As far as I can tell, no reason at all.
I never said that. I believe that screwing with it without an appreciation for the complexity of the system one is trying to improve upon can have dire consequences. And the purpose of this discussion is to see how to protect one’s self from these consequences.
The debt limit is actually pretty ineffectual at limiting spending, and now we’ve again been reminded that it can be exploited. But unconditionally making debt-limit increases automatic would sent the wrong message to legislators and investors. I think a balanced budget amendment would be a much better alternative.
Maybe I should look into emigrating to Canada again...
[/not sure if I’m kidding or not]
If the sh*t hits the fan in the US, I don’t see how Canada would remain unscathed. The question is where you can migrate your money, or more precisely, your purchasing power.
Canada’s banks did pretty well in the 2008 crisis.
If another global crisis comes, it will certainly affect some places less than others. Depending on how bad it gets, I guess switching countries for a few years might be worth considering.
Germany might be a good bet—it weathered the 2008 crisis pretty well, is rapidly gaining financial power over other EU countries and isn’t nearly as tied to the US as, say, the UK and China are. Everybody speaks English, too.
Do they? That’s interesting. I have a short list of countries to flee to if the U.S. gets too objectionable (“objectionable” deliberately unspecified) for me, but requiring English as a ubiquitous language is a serious limitation. Adding to that list is nice.
With regard to a potential U.S. default, I have no special plans because I have no significant dollar-denominated assets to protect. I’m not that well versed in what the fallout would be like, but I’d think the most likely threat to me personally would be unemployment, and I’m not sure there’s anything I can do about that except save money.
But I predict that the U.S. will not default—at least not this time.
I do too, for what it’s worth. I also predict that I will not die or become uninsurable during the coming year, but I pay my ALCOR dues nonetheless.
I suspect that this is all political theater, but in any ritual combat there the inherent risk that someone will miscalculate and things get real faster than anybody is prepared for.
Upvoted for the poignancy of the analogy.
It depends a bit where you go in Germany. If you want to spend your time in small towns German might be more important.
I live in Berlin and I know a bunch of people who live here that speak English but no German. They do quite well without German.
Physical location is harder to change than the location of your assets. Usually.