First, our behavioral finance perspective originates from looking for the probability of impending financial crisis. At Behavioral Finance Investment Advisors (BFIA) we create crisis indicators for all major global financial markets. Our crisis indicators for the U.S. goes back to 1970. Since then the indicator has never missed an impending crisis. Take a look at the figure below. Once the blue crisis indicator rises above its threshold it is a early warning signal that a crisis is imminent. For example, there were warnings before the 2008 crisis at the end of 2007. There were warnings of the tech crash in 1998 and 1999 etc.
Figure 1: BFIA United States Crisis Indicator vs.. Threshold
The question then becomes is the market worried about a U.S. default? The answer is no. Our current U.S. indicator is far below the threshold which indicates no crisis is coming this week. It is possible a crisis may occur next year but not now. The behavioral measures which extract behavior and expectations from the data show no worry of U.S. default.
Second, as trained economists what is our view of U.S. default. First, it is necessary to understand how money supply is created. Most of the money is created by debt via the banking system. Borrowers must pay back principal plus interest. If the banks do not recycle that interest back into the money supply there does not exist sufficient existing supply of money to pay back both principal and interest. Therefore, more money must be created creating more debt. This is okay if managed properly. However, the country with the reserve currency never has incentive to manage the government debt, Fed, and banking system properly given the benefits of having the reserve currency. Therefore, the end of the dollar as a reserve currency and collapse of its value is a given. Predicting when is something else.
What should an investor do? First, the market is not worried about U.S. default as of today based on our behavioral models. This means when a deal is struck there may be weakness in precious metals. Our economist view is that the collapse of the dollar is a given. Therefore, once there is weakness in gold and silver and Swiss francs, GLD, SLV, and FXF, it is time to pick up these ETFs for the long-run. Read More
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