In the financial world, it is unthinkable that America would default on it's debt obligation. Thats why in 2011 when we were on the edge of hitting the debt limit, treasuries rose in price! The cost of going into debt got cheaper, not more expensive, when we almost defaulted! Let's be clear, nobody really thinks that a "real" default will happen, but still serious is the risk that payments get interrupted for any amount of time.
Since it is fairly unthinkable that America would default, treasuries are used in several very big important ways. Firstly, yields on treasuries are considered the "risk free rate" in economic and financial models worldwide, and are used in setting the prices of many financial tools such as derivatives. Derivatives are used by banks and large companies to manage their financial transactions, lock in prices, or prevent losses beyond a certain point.
As treasuries are so important, it is hard to come up with alternatives. Because of that lack of creativity, a default might not have a terrible impact on the treasury market. What else can banks trade in such large quantities so easily? The short term impact might be minimal, but over the long term, risk of default, or interruption would be priced into bonds, raising the yield for the buyer, but increasing the cost of financing for the seller.
If people see rates rising, that means bond positions will certainly be money losers. Pulling money out of bonds leaves pretty much two places to put them - stocks or cash. That could be a plus for the stock market, and cash getting spent would be a plus for the economy. Higher financing cost would eat into the record high corporate profit margins right now and mess with stock valuations if there is not an accompanying rise in revenue.
Those are some portfolio impacts of a default. Next post I will look at the most frightening immediate economic consequence...
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