How could USA defaulting on its public debt influence the stock/bond market?
"This is a speculative question and there's no ""correct"" answer, but there are definitely some highly likely outcomes. Let's assume that the United States defaults on it's debt. It can be guaranteed that it will lose its AAA rating. Although we don't know what it will drop to, we know it WILL be AA or lower.  A triple-A rating implies that the issuer will never default, so it can offer lower rates since there is a guarantee of safety there.People will demand a higher yield for the lower perceived security, so treasury yield will go up.  The US dollar, or at least forex rates, will almost certainly fall. Since US treasuries will no longer be a safe haven, the dollar will no longer be the safe currency it once was, and so the dollar will fall. The US stock market (and international markets) will also have a strong fall because so many institutions, financial or otherwise, invest in treasuries so when treasuries tumble and the US loses triple-A, investments will be hurt and the tendency is for investors to overreact so it is almost guaranteed that the market will drop sharply. Financial stocks and companies that invest in treasuries will be hurt the most. A notable exception is nations themselves. For example, China holds over $1 trillion in treasuries and a US default will hurt their value, but the Yuan will also appreciate with respect to the dollar. Thus, other nations will benefit and be hurt from a US default. Now many people expect a double-dip recession - worse than the 08/09 crisis - if the US defaults. I count myself a member of this crowd. Nonetheless, we cannot say with certainty whether or not there will be another recession or even a depression - we can only say that a recession is a strong possibility. So basically, let's pray that Washington gets its act together and raises the ceiling, or else we're in for bad times. And lastly, a funny quote :) I could end the deficit in 5 minutes.   You just pass a law that says that   anytime there is a deficit of more   than 3% of GDP all sitting members of   congress are ineligible for   reelection.   - Warren Buffett" "The default scenario that we're talking about in the Summer of 2011 is a discretionary situation where the government refuses to borrow money over a certain level and thus becomes insolvent. That's an important distinction, because the US has the best credit in the world and still carries enormous borrowing power -- so much so that the massive increases in borrowing over the last decade of war and malaise have not affected the nation's ability to borrow additional money. From a personal finance point of view, my guess is that after the ""drop dead date"" disclosed by the Treasury, you'd have a period of chaos and increasing liquidity issues after government runs out of gimmicks like ""borrowing"" from various internal accounts and ""selling"" assets to government authorities.  I don't think the markets believe that the Democrats and Republicans are really willing to destroy the country. If they are, the market doesn't like surprises." Regarding the Summer of 2011 Crisis: There is NO reason that the United States cannot continue borrowing like it is just based on a particular ratio:  Debt to GDP. The Debt to GDP ratio right now is around 100%, or 1:1. This means the US GDP is around $14 Trillion and its debt is also around $14 trillion.  Other countries have higher debt:gdp ratios Japan - for instance - has a debt:gdp ratio of 220% Regarding a selloff of stocks, dollars and bonds: you have to realize that selling pressure on the dollar will make THE PRICE OF EVERYTHING increase. So commodities and stocks will skyrocket proportionally. The stockmarket can selloff faster than the dollar though. And both markets have circuit breakers that can attempt to curb quick selloffs. Effectiveness pending.
"The Dow Jones Industrial Average (DJIA) is a Price-weighted index.  That means that the index is calculated by adding up the prices of the constituent stocks and dividing by a constant, the ""Dow divisor"".  (The value of the Dow divisor is adjusted from time to time to maintain continuity when there are splits or changes in the roster.)  This has the curious effect of giving a member of the index influence proportional to its share price.  That is, if a stock costing $100 per share goes up by 1%, that will change the index by 10 times as much as if a stock costing $10 per share goes up by the same 1%. Now look at the price of Google.  It's currently trading at just a whisker under $700 per share.  Most of the other stocks in the index trade somewhere between $30 and $150, so if Google were included in the index it would contribute between 5 and 20 times the weight of any other stock in the index.  That means that relatively small blips in Google's price would completely dominate the index on any given day.  Until June of 2014, Apple was in the same boat, with its stock trading at about $700 per share.  At that time, Apple split its stock 7:1, and after that its stock price was a little under $100 per share.  So, post-split Apple might be a candidate to be included in the Dow the next time they change up the components of the index.  Since the Dow is fixed at 30 stocks, and since they try to keep a balance between different sectors, this probably wouldn't happen until they drop another technology company from the lineup for some reason.  (Correction: Apple is in the DJIA and has been for a little over a year now.  Mea culpa.) The Dow's price-weighting is unusual as stock indices go.  Most indices are weighted by market capitalization.  That means the influence of a single company is proportional to its total value.  This causes large companies like Apple to have a lot of influence on those indices, but since market capitalization isn't as arbitrary as stock price, most people see that as ok.  Also, notice that I said ""company"" and not ""stock"".  When a company has multiple classes of share (as Google does), market-cap-weighted indices include all of the share classes, while the Dow has no provision for such situations, which is another, albeit less important, reason why Google isn't in the Dow.  (Keep this in mind the next time someone offers you a bar bet on how many stocks are in the S&P 500.  The answer is (currently) 505!) Finally, you might be wondering why the Dow uses such an odd weighting in its calculations.  The answer is that the Dow averages go back to 1896, when Charles Dow used to calculate the averages by hand.  If your only tools are a pencil and paper, then a price-weighted index with only 30 stocks in it is a lot easier to calculate than a market-cap-weighted index with hundreds of constituents. About the Dow Jones Averages. Dow constituents and prices Apple's stock price chart. The split in 2014 is marked.  (Note that prices before the split are retroactively adjusted to show a continuous curve.)" "All bonds carry a risk of default, which means that it's possible that you can lose your principal investment in addition to potentially not getting the interest payments that you expect.  Bonds (in the US anyway) are graded, so you can manage this risk somewhat by taking higher quality bonds, i.e. in companies or governments that are considered more creditworthy. Regular bank savings (again specific to the US) are insured by FDIC, so even if your bank goes bust, the US Government is backing them up to some limit.  That makes such accounts less risky.  There's generally no insurance on a bond, even if it is issued by a government entity. If you do your homework on the bond rating system and choose bonds in a rating band where you're comfortable, this could be a good option for you.  You'll find, however, that the bond market also ""knows"" that the interest rates are generally low, so be ware that higher interest issues are usually coming from less creditworthy (and therefore more risky) issuers. EDIT Here's some additional information based on the follow-up question in the comment.  When you buy a bond you are actually making a loan to the issuer.  They will pay you interest over the lifetime of the bond and then return your principal at the end of the term. (Verify this payment schedule - This is typical, but you should be sure that whatever you're buying works like this.)  This is not an investment in the value of the issuer itself like you would be making if you bought stock. With stock you are taking an ownership share in the company. This might entitle you to dividends if the company pays them, but otherwise your investment value on a stock will be tied to the performance of the company.  With the bond, the company might be in decline but the bond still a good investment so long as the company doesn't decline so much that they cannot pay their debts. Also, bonds can be issued by governments, but governments do not sell stock. (An ""ownership share of the government"" would not make sense.) This may be the so-called sovereign debt if issued by a sovereign government or it may be local (we call it municipal here in the US) debt issued by a subordinate level of government.  Bonds are a little bit like stock in the sense that there's a secondary market for them.  That means that if you get partway through the length of the bond and don't want to hold it, you can sell the bond to someone else.  Of course, it will be harder to sell a bond later if the company becomes insolvent or if the interest rates go up between when you buy and when you sell.  Depending on these market factors, you might end up with a capital gain or capital loss (meaning you get more or less than the principal that you put into the bond) at the time of a sale." How is it possible that long term treasury bonds, which the government has never defaulted on, can hold more risk as an ETF then the stock market index? The risk from long-term bonds isn't that the government defaults, but that interest rates go up before you get paid, so investors want bonds issued more recently at higher interest rates, rather than your older bonds that pay at a lower rate (so the price for your bonds goes down). This is usually caused by higher inflation rates which reduce the value of the interest that you will be paid. Do you assume more risk investing in bond ETFs than you would investing in individual bonds? If you are choosing the right ETFs, there should be a lower amount of risk because the ETFs are taking care of the difficult work of buying a variety of bonds.  Are bond ETFs an appropriate investment vehicle for risk diversification? Yes, if you are investing in bonds, exchange traded funds are an appropriate way to buy them. The markets for ETFs are usually very liquid. "Because the USA is the world's biggest economy - everybody in the world works with the USA (even if the american companies are not direct suppliers, they are surely somewhere in the supply chain). If USA credit rating is lower, that means american companies will find it harder to get loans to finance their business (i.e. the price of capital will be higher), and this will consequently lead to higher prices for partners of american companies, etc. This will certainly lead to slowdown of global economy. Plus, the lower credit rating also means that the USA govt. is less likely to pay off the debts (Chinese already stated they will diversify their bonds portfolio -i.e. they will start selling out american govt. bonds). This will lead to cuts in public sector in USA, less spending by the consumers, also probably less import from abroad and less travel which will affect - you get it - the ""RoW"". It's not by chance we have a saying in Europe, when USA sneezes, the rest of the world catches a flu!" If you are actually referring to all the political rhetoric and posturing over the debt ceiling issue.  That's a long ways from the US actually defaulting on paying debts.  A lot of government offices might shut down, but I expect anyone holding US debt to be paid off. (they have the printing presses after all)  If that's what you are referring to, based on the LAST time that the governement had to shut down because they didn't raise the debt ceiling, it won't be a big deal.  Last time, no debt was defaulted on, a bunch of the less essential government offices shut down for a few days, and the stock market did a collective 'meh' over the whole thing.  It was basically a non event.  I've no reason to expect it will be different this time.  (btw, where were all these republican budget cutters hiding when 10 years ago they started with a nearly balanced budget, and ended up blowing up the national debt by about 80% in 8 years time? (from roughly $6B to $11B)  I wish they'd been screaming about the debt as much then as they are now. Not that there isn't ample blame to go around, and both sides have not been spending in ways that make a drunken sailor look like the paragon of a fiscal conservative, but to hear nearly any of them tell it, their party had nothing to do with taking us from a balanced budget to the highest burn rate ever while they were in control (with a giant financial crisis through in as pure 'bonus') That's true, though I feel he means it more in terms of hindsight. Yes, low interest rates will cause the stock market, as a whole, to rise. Though it is not actionable by us prior to the rise or fall in rates because we can never know before it happens.  We're then left with only one real way of making money in the market and that's the purchase of undervalued companies with all the aforementioned criteria. Smallest risk of default would depend on where Alice and Bob live I suppose, but lets assume they are in a lower yielding nation where default is not a big concern.  Remember for instance that Greece was a lower yielding nation at one point and that the US has defaulted before. Let's start with Bob because he is easier to analyze.  Yield curves inversions generally pre-date recessions which is generally not so good for Bob as rates tend to drop during recessions and he will be at the short end of the curve so his bonds will be less sensitive.  However, he will generally get higher yields in good times to make up for this, but these higher yields come with a price in that he is generally much more sensitive to yield changes and can get much larger swings in portfolio value. First off as JB mentioned Alice would likely own inflation-linked (IL) bonds.  Which behave fairly differently from Bob's bonds. However, to keep this simple lets say they live in a place without IL bonds or IL bonds are not a consideration.  Then generally Alice has lower yielding bonds in good times but may do very well when the fed steps in during a crisis. So, who wins in the long run?  Likely Christi who owns a mix of a broad index of stocks and bonds in a risk mix where she wouldn't have to sell in downturns.  Especially, as Christi wouldn't have to pay the trading costs of moving her whole portfolio between long and short bonds.  Between Bob and Alice however Bob would likely win in the long run as the markets generally reward risk taking in the long run.  Still inflation (even without the IL bonds) and general rate trends (long-term rates are historically low right now) could have Bob losing for uncomfortably long periods. I want to know too. Outside of the stock market there could be a lot of assets that aren't being supported as well as stocks by the US government. If that's the case we could be seeing another signaller showing the poor shape of the economy.