If the U.S. Defaults, How Will It Affect the Dollar?

Includes: FXF, GLD, SLV, UUP
by: Benzinga

By Paul Quintaro

In just over three weeks, the U.S. will default. According to Treasury Secretary Timothy Geithner, if the U.S. debt limit is not raised soon, the U.S. will be unable to meet all of its obligations.

On Monday, President Obama addressed the nation in a speech in which he outlined his desire to get a deal done in advance of the limit breach. Vowing not to sign any deal which would extend the debt ceiling only temporarily, Obama urged Congress to formulate an agreement which would constrain the nation's debt over the next decade.

Many market-movers such as Ben Bernanke and Warren Buffett have warned of the dangers of allowing the U.S. to default. Consequently, it seems fairly unlikely that Congress will fail to raise the debt ceiling. However, in the event of such a scenario, how would the dollar be affected?

On the one hand, the market may experience a noted sell-off in the dollar. An officially bankrupt federal government may send shock waves through the nation's economy. A weaker U.S. economy could mean a weaker U.S. dollar.

Inversely, traders could find the dollar strengthening in the event of a default. As the the U.S. remains the epicenter for the global economy, a defaulting U.S. government could send the world into an economic depression. In that case, traders may look to the dollar as one of the only safe plays around. That could see the dollar reaching new highs, similar to late 2008 when the dollar rallied in the wake of the financial crisis. Alternatively, a defaulting government could be seen as a sign that congress is serious about constraining spending. That could mean a stronger dollar in the long-run.

Action Items

Assuming traders believe that the debt ceiling will be breached:

Bullish: Traders who believe that it will be bullish for the U.S. dollar might want to consider the following trades:

  • Buy PowerShares DB US Dollar Bullish Index (NYSEARCA:UUP) in a long play on the U.S. dollar. If the dollar appreciates in value, UUP may do well.
  • Short SPDR Gold Trust (NYSEARCA:GLD) in a short gold play. Gold has traditionally rallied on dollar weakness, and if the dollar strengthens, gold may come under selling pressure.

Bearish: Traders who believe that a default will be harmful to the dollar's value may consider taking positions in the following:

  • iShares Silver Trust (SLV) in a long play on silver. Traders may seek a safe haven, and silver could appreciate in price.
  • CurrencyShares Swiss Franc Trust (FXF) is a long play on the Swiss franc. The franc has been seen as a hard currency in the past, and ought to rally if the franc appreciates.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.