Friday, October 4, 2013

A Guide to the US Federal Government “Shutdown”

A “shutdown” of the federal government began at midnight on October 1st. We placed the word shutdown in quotations because the government hasn’t truly shutdown. Rather, it has suspended all “non-essential” services and furloughed employees associated with those services. As a result, about 800,000 of the approximately 3.3 million federal employees, or just about 25%, have been furloughed. What follows is a guide to the issues involved in the shutdown and a discussion of the debt ceiling.

Why did the government shut down?
The government shut down because Congress failed to pass either a budget or a resolution to continue funding the government past fiscal year 2013, which ended on September 30, 2013. While passing a budget is one of Congress’ signature responsibilities, it’s one they haven’t met with regularity in recent years. In the absence of a formal budget, Congress must pass a continuing resolution, providing ongoing funding at current levels, to keep government agencies operating.

Will Congress and the President Still Get Paid?
You betcha!

Has the government shut down before?
Yes. While this is the first shutdown since the mid-1990s, it’s the 18th since 1975. From 1976 through 1987, the government shuttered operations on 14 different occasions. Shutdown’s occurred each year during the period with the exception of 1980 and 1985. Interestingly, five shutdowns occurred from 1977 through 1979 while the Democratic Party was in control of the White House and both houses of Congress! While many of the shutdowns lasted less than five days, five have lasted more than 10 days. To state the obvious, the current shutdown, while unusual, is far from unprecedented.

What is the likely impact on the Economy?
Simply put, that depends on how long the shutdown lasts. If it lasts a week, the economic impact will likely be modest. While furloughed employees are not paid, they will receive back pay (at least they always have following past shutdowns) once the shutdown ends. That, coupled with the fact that the shutdown is occurring at the beginning of the quarter, suggests that most of the reduced consumer spending that may occur due to the furloughs will be recouped prior to the end of the year. On the other hand, Mark Zandi, Chief Economist of Moody’s Analytics, estimates that if it were to last three or four weeks, it could shave 1.4 percentage points from annualized 4th quarter GDP.

What about the Debt Ceiling?
Federal debt has been statutorily limited since the Second Liberty Bond Act in 1917. Prior to the Act, Congress had to pass legislation approving each debt issuance. The Act was expected to make it easier to raise debt while simultaneously keeping debt accumulation under control. While the debt ceiling was briefly lowered following WWII, it has been consistently raised since it was enacted. This, in and of itself, is not surprising. Nor, until about the early 1980s, was it problematic. The debt ceiling is a flat dollar amount. As the economy has expanded over the last 100 years, the nation’s ability to service debt has grown dramatically. However, beginning in the 1980s, the pace at which the debt ceiling has grown has accelerated, yet this acceleration has not been matched by the rate at which the economy has grown. As a result, our debt/GDP ratio, i.e. debt relative to the size of the US economy, has grown dramatically.

While the debt ceiling and the budgetary impasse are technically separate issues, they are indeed intertwined, politically and economically. Politically, it has become a bargaining chip in budget negotiations. Economically, budget decisions largely help define the degree to which the debt ceiling must be raised. The reality of the last 70 years is that Congress has generally passed budgets and the debt ceiling has been raised to accommodate increased spending. This has been true regardless of which party has controlled the White House or Congress.

The Treasury has suggested it will exhaust its resources by mid-to-late October, resulting in the need to issue debt, which it will not be able to do unless the impasse over the debt ceiling has ended. If that were to occur, there is a legitimate possibility that the Treasury would be forced to delay November 1st Social Security payments according to Capital Economics. If it were unable to make interest payments on November 15th, the US would be in default. Given the very dire consequences of not raising the debt limit, we believe that Congress will act, if not by mid-month then by the end of October, if only for their own self-preservation.

As of this writing, both sides appear to have dug in their heels for a long fight over the budgetary impasse that has resulted in the “shutdown.” However, polls suggest that voters are unhappy with both parties over the shutdown and that may be enough for cooler heads to prevail, but only time will tell. We are not political analysts and we will not prognosticate on the length of the shutdown. Suffice it to say that the degree to which the shutdown impacts the US economy will largely depend on how long it lasts. Meanwhile, the debt ceiling has the potential to be a far greater issue. Politicians have a tendency to compromise when forced to do so. Congress has repeatedly pushed the envelope on financial deadlines over the last two years, battling until coming to some form of agreement at the 11th hour. Admittedly, continuing to do so increases the likelihood of going to the proverbial well once too often, missing a deadline and creating a true crisis. However, it’s likely that over the next several weeks Wall Street financiers, economists, global central bankers, and corporate CEOs will make it abundantly clear to Congress that failure to raise the debt ceiling would be disastrous. In short, while we wouldn’t be surprised by an extended shutdown, we expect the debt ceiling to be raised, taking the most potentially damaging issue off the table, at least for the immediate future. But this is no way to run a country, let alone the greatest military and economic power the world has ever known.