By Ziad K. Abdelnour
One week has already passed since the Oct. 1 federal government shutdown forcing massive furloughs of workers and suspension of services not excepted by the Anti-Deficiency Act.
Because Congress did not enact regular appropriations or a continuing resolution for the 2014 fiscal year, appropriations have lapsed, and about 800,000 federal employees were indefinitely furloughed without pay, while another 1.3 million “excepted” employees were required to report to work for some indefinite period without pay until an appropriations bill is passed or their function is no longer excepted.
The U.S. government has shut down 18 times since 1976. The last actual shutdown came in 1996 and lasted three weeks.
Two basic questions that come to mind:
- What really happened here that got us again at that same impasse of 17 years ago?
- What are the implications if the government were to ever default?
So, a “funding gap” was created when the House of Representatives offered a Continuing Resolution with language delaying or defunding Obamacare. The Senate stripped the Obamacare language from their version of the measure. Congress was unable to reconcile the bill, allowed funding to lapse, and a full-government shutdown began.
Political fights on this and other issues between President Obama, the Democratic-led Senate and the Republican-led House have led to a budget impasse that threatens massive disruption and possible default on the Full Faith and Credit Clause of the U.S. Constitution.
Although there were reports that enough House Republicans could have allied with House Democrats to pass a “clean” continuing resolution with no funding limits for the Affordable Care Act (17 Republicans and all 200 Democrats were said to be needed to pass the resolution), House Speaker John Boehner would not allow a vote on such a resolution.
On Oct. 2, the House proposed several piecemeal bills to fund national parks and museums, the NIH and the city of Washington, D.C. After initially failing to reach two-thirds majority needed to suspend the rules, all three passed the House with bipartisan (but predominantly Republican) support – but Senate leadership and the president rejected these efforts, arguing that they represented an attempt to reduce political pressure on the GOP to resolve the shutdown by funding a few politically popular agencies while ignoring other important services.
Likely economic effects of the shutdown?
Moody’s estimates that a shutdown of three to four weeks would cost the economy about $55 billion. Lost wages of federal employees will amount to about $1 billion a week, while Goldman Sachs estimates that a three-week shutdown would reduce the GDP of the United States by 0.9 percent. By comparison, the GDP has grown by less than 2 percent in 2013.
I am still not sure which party is winning what by continuing this never-ending gridlock, especially at a time when Congress and the president must agree to raise the debt ceiling to avoid the prospect of defaulting on the public debt if a new debt ceiling is not approved by Oct. 17.
On Oct. 2, President Obama explicitly linked the government shutdown to the debt-ceiling issue, stating that he would not reopen budget talks until Republicans pass a bill raising the debt limit.
Now what would happen come Oct. 17 and debt limit is not raised?
- At the most basic level, the U.S. Treasury Department won’t be able to borrow any more money. While new tax revenue will continue coming in, if the government cannot borrow, then it will not be able to pay all of the bills due that day.
- With $18 billion in big government bills due by Oct. 31, if the government missed any of its payments, it would default on its obligations. If it missed an interest payment, it would default on its debt, which is considered particularly serious.
- If the government shows any hesitation in making scheduled interest payments on its outstanding bonds, investors will demand higher interest payments when the government borrows money in the future. That would add significantly to the federal budget.
- If the government is forced to pay higher interest rates, the borrowing costs for businesses and homeowners would rise as well. This would lead to less borrowing, which would put a brake on our already sluggish economic growth.
- Banks already have large holdings of Treasury bonds. If the value of those bonds suddenly dropped, banks would have less money on hand and would be less likely to lend to one another, potentially causing a freeze in the credit markets like the one in 2008.
- Because investors have long believed that the U.S. government would always be able to pay its bills, Treasury bonds have become the bedrock of the global financial system and the dollar has become the most widely used currency in the world. If investors come to doubt the ability of the U.S. to pay its debt, the dollar could lose its special status.
- When investors believe a default is likely, the stock market will almost certainly plunge. So far, the markets have suggested that Congress will ultimately come to an agreement, but the mood is growing darker. On Oct. 3, the Standard & Poor’s 500-stock index had its worst day in more than a month, and it was just a few weeks ago, on Sept. 18, that the Dow set an all-time closing high of 15,676. As worries about the shutdown and corporate profits have grown, the Dow has slid to 15,133. That’s about 3.5 percent, less than what happened when the federal government shut down for a total of four weeks in 1995 and 1996. Remember the crisis of 2008? The Dow Jones industrial average lurched up and down by hundreds of points in minutes. It lost almost 5,000 points from the collapse of Lehman Brothers to the market bottom six months later.
- Another barometer is the price of insurance investors can buy against losses on Treasury bonds, known as credit default swaps, which rises as the possibility of a default rises. The price of such insurance has been climbing over the last three weeks and jumped sharply on Oct. 3. But it is still below the level it reached in the summer of 2011.
If you think the current government shutdown is problematic, wait for a global catastrophe to happen if we would hit the debt ceiling and default.
Frankly, nobody really knows what will happen if we breach the debt ceiling because it’s never happened before. And everyone worries that it will be catastrophic because nobody created any legal provision for not making it catastrophic.
There’s no guarantee that it will lead to a worldwide financial panic and a massive global depression, but there’s also no guarantee that it won’t.
None of this is rocket science – but unless Republicans and Democrats come to terms with what is exactly at stake in here, a default would be unprecedented and has the potential to be an economic calamity.
Ziad K. Abdelnour is president and CEO of Blackhawk Partners, Inc., founder and president of the Financial Policy Council and Author of “Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics.
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