The DJIA has fallen from 12,745 a week ago to 12,330. If recent history is any indication, that move down could quickly become a 2,000 points one if the federal government cannot come up with a solution to the debt ceiling that both increases what the Treasury can borrow and offers a long term plan to significantly close the gap between revenue and expense.
The credit crisis pulled down the DJIA from 11,390 in late September 2008 to 8,450 less than a month later. The index continued to skid through the following spring, but the worst damage was done in the first 30 days of the sell-off. The credit crisis was too much for the market to bear. The global financial system faced a catastrophe. Many concerns about the system came true.
Predictions about what may happen if the government defaults are worse than the difficulties of 2008 and early 2009. The most dire among them is that a rise in the federal government’s borrowing costs will be passed through the system to a wide range of interest rates on anything from large corporate bond issues to car loans. Movement in the dollar may pressure oil prices higher. Companies without access to adequate cash will likely fire workers.
The other aspect of a default that is particularly frightening is the ripple that will be caused by a suspensions of Social Security payments and wages to government workers. These two groups represent millions of people. It would not take more than a week or two of compensation interruption to end their status as consumers. GDP growth, as modest as it is, would be ruined.
All of these horrible results would mean widespread suffering among those affected. The stock market would bear much of the brunt, on a more mundane level. No one should forget that the 2009 market collapse wiped out trillions of dollars in household net worth and the retirement funds of millions of middle-aged Americans. Whatever renewed faith investors have developed in stocks over the last two years would be destroyed, and it might remain that way for a generation if results were bad enough.
A drop in the stock market may appear to be nearly unimportant compared to the worst effects of a default. It only looks that way until the harm done to the savings of Americans and the value of their pensions is considered. A 15% to 20% downward adjustment to the DJIA could cause as much damage as the drop in 2009.
Douglas A. McIntyre