In the decade or so that I've really been following stocks and finance, I've learned a few lessons that I think many people involved in markets still don't understand. I've learned that when a crisis is coming, be it an end to the tech bubble, a housing bubble, or problems in the mortgage market, most people will not acknowledge it until the market is well down that path. I've also learned that when these things happen, they have a tendency to collapse in on themselves and compound the initial trouble. So when I read this entry on the CFO blog about the possible bankruptcy of the U.S., I began to wonder if this will happen, and if so, what that means for me.
Now, the other side of all this is that dire predictions happen all the time that never come true. How many times have we been told that the world was coming to an end, that we are almost out of oil, or that Y2K was going to bring everything to a halt? The issue I struggle with is how to tell when the doom and gloom prophets are being reasonable (and seeing some data point the rest of us don't), and when they are being fearmongers.
One gauge I use to analyze issues like this is the various incentives of the people involved. Companies that offered solutions to Y2K issues benefited from predicting doom and gloom, so their predictions need to be discounted a bit for that. With respect to the issue of a bankrupt U.S. government, I don't initially see how a few economics or accounting professors benefit from such predictions. I assume they are being reasonably honest.
A second gauge I use is the structure of the overall situation, and whether it is possible for such an idea to get traction with the parties involved if it is true. Evolution is a great example here. Less than half of Americans accept it because it doesn't mesh well with the other things we want to believe. Our cultural and social systems prevent such an idea from becoming mainstream. So with respect to a bankrupt United States, if these predictions are true (and that is a big if), could the idea become mainstream enough to initiate any change? I think no, not until it happens. Populist politics will prevent it. No one will ever get elected who preaches sacrifice, savings, and fiscal discipline. The country will either need a vast cultural change, or we will have to directly experience the effects of a bankrupt U.S. to accept the policies that will get us out of that situation.
Incentives matter sooooo much when it comes to predictions and decision making, and I suspect that if this happens, it will occur only after many pundits are on national television explaining why it won't. These are, of course, the people who don't want it to happen and are often blinded by wishful thinking. But those "Dow 36,000" types are always out there before a crisis.
This isn't the first time I've heard the bankruptcy of the U.S. come up. I wonder if the people predicting this are the same people who, in 2003 and 2004, were the sparse voices talking about a housing bubble. I don't know enough about the issues involved to really make a good judgment, but I do know that historically, it has been very common for such fiscal mishaps to catch countries by surprise. Given the stupidity of the average politician, I think I'll err on the side of pessimism and protect my long-term downside risk.