So let's say that U.S. debt is downgraded and/or the U.S. defaults. Presumably, under either scenario investors wouldn't be amused. Some would dump Treasuries by choice while others would do so by necessity, due to fund requirements. If millions, billions, or trillions of dollars flee Treasuries, where do they go? Unfortunately, there aren't enough good alternatives.
Here's a chart from a note released on Wednesday by rating agency Fitch that demonstrates the problem:
First, bear in mind that U.S. agency debt these days is equivalent to Treasuries in every way that matters. The U.S. government indirectly pays those bonds and explicitly guarantees them. If Treasuries are downgraded or defaulted on, agencies would probably face a similar fate. So we should add another $2 billion+ to the bar for Treasures to extend it to around $11.5 trillion. Now if you add up all of sovereign debt from France, the U.K., Germany and Canada, along with the covered bonds from Germany and Spain, you only get $7.4 trillion. AAA-rated corporate bonds are a much, much smaller market than AAA-rated sovereign debt, so their impact is virtually negligible.
As a result, if Treasury investors want to dump U.S. debt and buy other AAA-rated debt instead, they may have some trouble finding enough supply. They'd likely have to settle for something like gold (or other commodities), cash, or cash equivalents. Our friends at 24/7 Wall ST have compiled an expanded list of possible investment alternatives for those exiting the Treasury market, which we ran earlier today.