Update: Thanks everyone for the continuing thought-provoking discussion. I intend to post my decision spreadsheet, and still am looking for suggestions on where to do so. It might come in handy come February. A discussion that I find interesting has branched off on the topic of technological progress versus Malthusian Crunch, and I started a new article on that over here.
I would like to kick off a discussion about optimal strategies to prepare for the event that the US government fails to raise the debt ceiling before the US Treasury Department's "extraordinary measures" are exhausted, which is estimated to happen sometime between October 17th and mid-November.
This is a risk *caused* by politics, but my goal is to talk about bracing against the event itself if it happens, not the underlying politics. If you want to debate Obama-care, who is at fault, or how likely a US default actually is, please start a separate discussion.
I consider this to be an indirect existential risk because if it kicks off a national or global recession, it will likely slow or halt research and philanthropic efforts at mitigating longer-term existential risks.
Since there are obvious associations between unemployment/poverty and crime, civil unrest, and poor health, a global recession is likely to be to some extent a personal existential risk to those living in the United States or countries that have trade links with the United States.
I notice that the markets do not seem to be anticipating a bad outcome. But I heard one analyst advance the theory that investors simply don't believe the government can (his words) "be that stupid". I imagine there is more than a touch of availability bias as well-- breaching the debt ceiling might, even for fund managers who harbor no illusions about the wisdom of politicians, be up there with science-fictional scenarios like asteroid impact, peak oil, grey goo, global warming, and terrorist attacks. Moreover, there may be a dangerous feedback loop as the politicians in turn watch the stock indexes and conclude that "the market says there is nothing to worry about".
So, I would like to hear what folks who are making contingency plans are doing. Especially people who have training or experience in economics and finance. What do you think the closest parallels in 20th/21st century history are for what the worst case scenario for a US government default would be like? Is there anything you would have done differently if you had known the date for the start of the 2008 recession with a +/- 2 week confidence interval, starting in two days? Or, if you did call it ahead of time, what are you glad you did?
Hedge or don't hedge. Hedge a little or a lot. But if you want to hedge but have a "Heee-yal no!" response to the simplest hedging strategy suggests some inconsistency somewhere.
Again, to the extent that you believe that the risk is a small chance of not paying out US treasury bonds then the obvious hedge is to short sell said asset. You want it to be only slightly costly, which places limits on how much hedging you can do via this (or any other) method. Since the market value of US treasury bonds cannot increase significantly without becoming mathematically absurd this is not a risky move.
You can likely optimise beyond this approach but if the strategy seems drastically aversive rather than potentially inefficient then something is broken.
I must admit, I don't really understand bond pricing (which by itself probably means I'm not ready to be shorting them). I wouldn't short a stock unless I was very confident it would go down, because if I'm wrong there is no theoretical limit on my losses, unlike being wrong about a long position. If a default is averted, there could be a market rally, and people shorting index ETFs would get screwed for example. Does it work differently for bonds?