The US Government Shutdown and the Debt Ceiling

The US Government Shutdown and the Debt Ceiling

The partial shutdown of the US federal government has been in effect for a week, and currently both sides are refusing to compromise. This implies that the standoff between Republicans (who control the House of Representatives) and the Obama Administration (who need Congressional authorization to make the payments) could continue until the Treasury uses up its entire (approved) borrowing capacity. The Treasury estimates that this would occur on Oct. 17, and its remaining cash balances would only suffice for another week or two at most (i.e., until month-end).

Together these two deadlines form “book-ends” for the probable most intense phase of the crisis. However, I believe it is inconceivable that either side will push the confrontation to the point where the US defaults on one or more of its outstanding obligations (e.g., repayment of principal on maturing bonds, or interest coupons on those bonds), thus triggering an outright default and initiating the process of downgrading by the rating agencies. Such intransigence would be hugely damaging to the reputation of the United States as a borrower both in the short term and beyond. It seems likely, therefore, that the crisis will be resolved within the last two weeks of October. The resolution could either come via a bill that deals with both the current budget and the debt ceiling together, or via standard continuing resolutions (CR) and a new debt ceiling, both in return for some concession by the White House on future spending plans.

Likely economic and financial market consequences?

In terms of the direct effect on federal government employment, initially some 800,000 federal employees were temporarily “furloughed” (temporarily discharged), but already the Defense Department is reducing the number of furloughed workers. This is thanks to a changed interpretation of the definition of “essential” civilian employees, effectively maintaining about 400,000 more people in employment. In addition, legislation has just been passed to enable furloughed workers to be paid retroactively. These temporary “fixes” are a two-edged sword. On the one hand, they ease the anxiety of affected employees, but on the other, they reduce the pressure on Congress and the Administration to reach an agreement.  Even so, the direct impact of the federal employee layoffs is reducing the gross domestic product (GDP) by around $160 million each workday, and when other effects (such as deferred contracts, closure of private businesses directly dependent on government, and related disruptions) are added, the total is more than doubled — around $1.6 billion per week compared with an annual GDP of $15.7 trillion. As Bloomberg expressed it, this Washington-made calamity is on a par with a natural disaster such as the recent Colorado floods that cost $2 billion. If continued, it would be like one hurricane per week for as long as the stand-off lasted.

The impact on markets is much more difficult to gauge. While some holders of Treasuries may sell down their holdings, or buy less in the future, this was not what happened in the summer of 2011, the last time Congress refused to extend the debt ceiling. On that occasion, expectations of damage to economic activity caused a “growth scare,” prompting investors to sell equities and buy bonds — including Treasuries — as a safer alternative. The US dollar even strengthened between August and October 2011. In short, the safe haven qualities of US Treasuries and the currency won out over concerns about the creditworthiness of the US federal government. A similar outcome is entirely possible on this occasion, although the better economic fundamentals of foreign economies make the currency more vulnerable this time.

John Greenwood

Chief Economist

Invesco Ltd

Based in London, John is Chief Economist of Invesco Ltd. with responsibility for providing economic analysis and forecasts to Invesco portfolio managers and clients.

John started his career in 1970 as a visiting research fellow at the Bank of Japan. He joined our company four years later in 1974 as Chief Economist, based initially in Hong Kong and later in San Francisco. As editor of Asian Monetary Monitor in 1983, he proposed a currency board scheme for stabilising the Hong Kong dollar. John was a director of the Hong Kong Futures Exchange Clearing Corporation for four years until 1991, and in 1992 became a council member of the Stock Exchange of Hong Kong, a position he held for twelve months. In that same year, he was an economic adviser to the Hong Kong Government. He has been a member of the Committee on Currency Board Operations of the Hong Kong Monetary Authority since 1998. He is also a member of the Shadow Monetary Policy Committee in England, and he serves on the board of the Hong Kong Association in London.

John holds an MA from the University of Edinburgh, and an Honorary PhD, also from the University of Edinburgh.

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