A rusty, clunky, battered locomotive hauling dozens of railcars is slowly climbing a steep grade. It’s in rough shape, but it’s moving along at a steady clip. If we could just keep it going a little longer, we’d be out of the valley and onto level ground.
So what do the engineers decide to do? They shut the locomotive off. Yup, they just switch off the engine. Bye, bye flat level ground. Hello again, deep dark valley we almost left behind.
Such is the risk posed on the struggling U.S. economic recovery by a potential government shutdown next week… the risk of slowing, stopping, reversing, and ultimately derailing America’s ascent out of the darkest and deepest recession of the last 80 years.
Just what are the federal parties fighting about that would provoke them to threaten shutting the government down, jeopardizing the economic recovery?
Out of Cash
The U.S. government is about to run out of money… again. It’s actually pretty common, really.
When the government renews its budget each year, any shortfall is simply borrowed from banks, other nations, or even its own citizens by selling bonds. Budget deficits are extremely common and readily resolved through borrowing.
Until the government runs out of credit, that is. When the U.S. has borrowed up to the full limit it is allowed, Congress has to approve a credit limit increase to allow the nation to keep borrowing money to stay in business for another year.
Yet this too is easily resolved, usually rather quietly with very little public outcry or commotion. Most people aren’t even aware that in the last 50 years, the U.S. credit limit has been raised 77 times – an average of once every eight months.
But since 2008, the process of raising the debt ceiling has become a wearisome and exhausting ordeal, with threats by a large part of Congress to block the approval of a credit limit increase. If the dissenters are successful this time around, the government would not be allowed to borrow more money. When what little money it has finally runs out on September 30th, the government would be forced to shut down beginning October 1st.
It’s All About Obamacare
The issue splitting Congress apart is the funding of Obamacare, the $1.1 trillion ten-year overhaul of the nation’s health care system. Republicans want to block its funding and redirect that money to the economic recovery, and they have threatened to block next week’s vote to raise the nation’s credit limit as a means to that end.
Yet the threat is more of an expression than anything practical, as the funding of President Obama’s health reforms have nothing to do with Congress. Because health care is considered an essential service, health expenses are automatically funded by the government regardless of its credit limits. The government is already pre-authorized to borrow beyond its credit limit for all essential services, including Obamacare.
Thus, any blocking of next week’s Congressional vote to raise the debt ceiling is purely symbolic, much like the dumping of crates of tea into Boston Harbor in 1773. Republicans feel they must make a statement to notify the citizenry of how important repealing Obamacare is to America’s finances and its economic recovery.
Very Real Consequences
Yet the effects of a government shutdown will carry some pretty hefty consequences which are not limited to the harmless realm of symbolism. The damage caused would be very, very real. Here’s just a general overview:
Lost revenue: The government stands to lose untold tens of millions of dollars on the closure of parks, monuments, and other tourist and vacation locations.
Lost wages: Most government employees – with the exception of essential personnel, such as air traffic controllers, hazardous waste handlers, food inspectors, and others – will not be getting paid during the shutdown. Forbes calculates that government employees make up about 6.9% of the U.S. population. With the current unemployment rate at 7.3%, a government shutdown almost doubles the portion of the population not collecting a pay check. Even if it is only temporary, it would still amount to tens of millions of dollars not making their way into the economy, not to mention into mortgages. As if it wasn’t already difficult enough for families to make ends meet and hold on to their homes.
Lost GDP: Since the government is ever more reliant on private-sector contractors and companies for goods and services to the tune of some $300 billion worth of products and labor each year, $820 million of economic production would be erased each and every day that the government remains shut. Such expenses were not retroactively paid when the government reopened after the last two shutdowns in 1995 and 1996, and they would not be paid this time around either.
There is never a good time for a government shutdown, even less so at a time when the nation is still struggling to get out of the deepest recession in a generation. It is utterly irresponsible of government representatives – who were elected for their wisdom and education to serve the populace – to intentionally inflict such damage on the economy at such a crucial time.
And for what? For nothing more than a symbolic gesture that doesn’t even have an effect on the purpose for which it is intended, namely the repeal of Obamacare.
For a general idea of how a government shutdown would affect equity and bond markets, we need only look to the past five months since May.
Very simply put, a government shutdown cuts the flow of money from the government into the economy. It is the opposite of stimulus and amounts to the removal of a large portion of the stimulus injected into the economy over the past few years.
Do you remember how the markets reacted back in May when they believed the Federal Reserve was going to reduce its stimulus measures? The S&P 500 index lost some 7% from May to June, while the 10-Year U.S. Treasury yield rose from 1.6% in May to as much as 3% earlier this month. Mortgage rates also soared 1.15% from 3.35% in May to 4.5% last week.
To make matters worse, any failure by Congress to approve a debt limit increase would leave the government without cash to pay its foreign or domestic debts – resulting in default – likely triggering credit rating downgrades by rating agencies.
Do we remember what happened the last time the U.S. had its credit rating downgraded on August 5th, 2011? The S&P 500 – which had already been falling – lost some 20% in total, while gold soared $250 in two weeks, after having already climbed $200 the month prior.
The potential for a severe market correction this time around is greater, though, as equities have just recently hit their all-time highs and have been steaming and chugging up that recovery hill for some 5 years without a sizable correction.
Perhaps next week’s potential government shutdown is a danger the Federal Reserve wanted to make certain was behind us before introducing its long anticipated stimulus tapering. In his press conference last week, Chairman Bernanke did mention the potential shutdown as a serious threat to the economic recovery.
Going into next week’s crucial congressional vote on the raising of the debt ceiling, investors should reduce their leverage, up their cash, and remain defensive. And by all means, avoid companies that rely on government subsidies or contracts. You might even try a speculative put option for a little bonus, just in case there is a stoppage.
Just keep in mind that the likelihood of a government closure is slim. Even though there have been as many as 17 shutdowns since 1976, there has not been one since 1996. As well, any effects should be temporary, as the previous closures lasted from one to 21 days. Both parties know it would do more harm than good and will likely avoid it.
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