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Much has been said about the rapidly approaching cliff of a U.S. default on its debt obligations should the debt ceiling not be raised by October 17th. Politicians, media, and self proclaimed experts loudly are proclaiming that any default would be a global financial Armageddon.

Concerned investors have no doubt been closely reading many of the articles pouring forth in a flood of debate as to how extensive the damage will be and who's must bear the blame if the U.S. tumbles past October 17th without any action to move the debt ceiling impasse before that so called doomsday date. Each day, I read advice and arguments about how fast defaults will occur and how fast and widespread the consequences will be. I have seen authors argue that global economic recession looms within days or at most weeks if the U.S. debt ceiling is not raised within the coming 48 hours.

The biggest problem with all of these fear scenarios is that they are simply lies or the wisdom of fools (and not the lovable Foolish ones inhabiting our cousin's website).

The positions of the doomsayers cover a wide range which I summarize in the following list:

  1. Failure to raise the debt ceiling by October 17th will result immediately in defaults and send the global economy into a tailspin along with permanent damage to the U.S. reserve currency standard.
  2. Immediate default on payment of entitlements such as social security and Medicare will be needed in order to allow the U.S. to continue to pay its Treasury debt obligations and thus avoid technical default. This, the doomsayers claim, is not a technical default but will none the less damage the U.S. credit and harm the economy and millions of dependent beneficiaries.
  3. October 17th is a soft deadline which will not trigger any immediate issues but those issues, beginning with those raised in #2 above and soon thereafter proceeding to #1 classic default will follow within the ensuing days and a few short weeks.

Which one of these dire scenarios do you believe? More importantly, which of them should a prudent and cautious investor be adjusting their portfolio for just in case the debt ceiling is not raised by October 17th, or even by November 17th? or (GASP!!!) by January 17th?

To find the best answer to this question, a wise investor must back up and first explore the validity of the scenarios before judging the consequences and how to hedge for those potential consequences.

The federal budget for 2013 is $3.7 trillion. Of this amount, $0.222 trillion (or $222 Billion) is debt service on the federal debt. This calculates out to 5.95% of the total federal budget for 2013 (or also for 2014 assuming sequestration levels remain at currently provided by law). The U.S. can easily avoid default on its Treasury debt by either delaying or reducing other federal spending by 5.95% or finding alternate sources of revenues to pay those amounts (or by a combination of those methods).

In addition to avoiding default on current debt obligations, the government needs to borrow $522 billion in new net funds to continue spending at current sequestration levels for fiscal 2014. Thus a total of $744 Billion (the total U.S. FY 2014 deficit) is needed to continue everything at current levels without borrowing further. $744 Billion for the year breaks down to $62 Billion per month on average.

Where can the debt and deficit ridden Federal Government possibly find $62 billion per month to forestall new borrowing, spending curtailment, or defaults? Let's take a look at that problem.

The U.S. gold in Fort Knox is worth approximately $187.4 Billion (147.3 million ounces X $1,275 per oz.). Add to that the $64.5 billion value of the oil in the U.S. strategic petroleum reserves. This yields total liquid assets not being used for anything currently (and thus the liquidation by futures selling and/or outright spot sales causing zero impact on federal balance sheet or economic impact on any federal programs). If futures selling is employed wisely, long term leaps need not result in any actual liquidation and delivery of the currently held like kind U.S. assets and well managed could even result in net profits for the U.S. Treasury as it closes its positions through buying to cover on the market dips once the debt ceiling issues are resolved.

This total of almost $212 billion represents over 3.4 months coverage for debt service plus new deficits incurred at current federal budget levels. Thus the looming October 17th deadline we are supposedly facing within 48 hours is pushed to beyond February 15, 2014. All this done without ANY EFFECT WHATSOEVER on the Federal balance sheet nor federal spending, including spending on all current debt service.

Now that we have a better understanding of the looming cliff (or lack of a looming cliff), investors can evaluate the need to take near term action to adjust or hedge their portfolios to deal with this fake disaster around the corner. Any such fears have no reason to occur before the 2nd fiscal quarter of 2014 even if congress were to remain paralyzed until then.

My suggestion to investors therefore is to stay the course. In fact, prepare for market rebounds to the upside in the near term as either the government provides at least temporary legislative relief or these alternate Treasury options are put into use to deal with the current situation. Opening of suitable long positions (I suggest through calls) on the S&P500 (NYSEARCA:SPY), Dow (NYSEARCA:DIA), (NASDAQ:QQQ), VIX volatility (NYSEARCA:VXX) or (NYSEARCA:VXZ).

The fearmongers have created a straw man that simply does not exist. If you have just lost your job and have $5,000 in monthly bills coming in against no income AND you have $20,000 cash, gold, stocks, or other immediately liquid net assets) then you are not in immediate trouble. You do not even have to change your habits if you are confident you will remedy your current situation within the 4 months before those liquid assets run low. The same is true for our federal budget and government.

The safety relief valve I suggest exists not just in theory. I believe it is the legal obligation of the President and the Secretary of Treasury to take such steps to protect the faith and credit of the United States Government as provided in their oaths of office and the constitution (while the 14th amendment does not give the President the power to ignore the debt ceiling but it does impose upon him the duty to use all legal means at his disposal to protect the integrity of the U.S. debt.)

Source: The Myth Of A Looming Default: Lies, Damn Lies And Statistics