Decoding US Government Shutdown-VRK100-27Sep2013

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What is US Government Shutdown?

A US government shutdown is the inability of the US federal government to provide public services, to meet its debt obligations and to run various government departments smoothly. The US government is facing a possible shutdown by 1^st October technically. But the real shutdown may take place after 17^th October as indicated by the US treasury secretary Jacob Lew. The full faith and credit of the US government would be in peril.

The US federal government needs money to meet its obligations—such as social security benefits, military salaries, interest and principal payments, tax refunds and others. The money is made available through the budget approved by the US Congress—consisting of Senate and House of Representatives. If funds are not available, the government comes to a grinding halt. So, why is the US in such a mess?

Reasons behind the fund crunch:

The reasons are both political and economic. The Republican and Democratic party members are sparring in the US Congress over increasing the federal government’s debt ceiling. The Republicans want president Barack Obama to postpone his Obamacare by one year and some legislative action on tax and environment matters. Obamacare, which is effective 1^st October, is shortened form of Affordable Care Act. It provides health care benefits to US citizens. The Republican proposals are shot down by the Democrats and the president; and the standoff continues at present. With majority members belonging to Republican party, the House of Representatives is controlled by it. But the Senate is controlled by the Democrats.

In fact, the acrimony between the two parties has been going on for the past three years. In 2011, the US government almost came to a standstill, but was averted at the last minute. Under president Bill Clinton’s regime, the US government experienced shutdown intermittently for about four weeks between November 1995 and January 1996.

For more than two decades, the US has been living beyond its means. It has been unable to balance its budgets—with expenditure being more than its revenues. The US consumption has been a boon to exporting countries, such as, China, Japan and Germany. In turn, several non-US countries invest in US Treasury securities, helping bridge the US budget deficits for a long time. But in the aftermath of the 2007/2008 global financial crisis, the tepid US economic growth has further worsened the US budget deficits. 

What is debt ceiling?

Debt ceiling is the total amount of money the US federal government is authorized to borrow to meet its existing legal commitments. The US Congress is in the habit of raising debt limits regularly. In fact, the ceiling has been raised 78 times since 1960. In the following weeks, Congress leaders of both parties have to agree to raise the debt ceiling and make it into law, failing which the US government has to shut down.  

 The US deficit cannot go beyond the debt ceiling approved earlier by the US Congress. The US federal government has to spend within the debt ceiling set by the US Congress. The money is needed to pay nation’s expenses and borrowings. Before 1^st October, there has to be an agreement in the US Congress between the two parties.

The current federal borrowing limit is $16.7 trillion—the total public debt outstanding has already reached this limit. The Republicans are refusing to enhance this limit, resulting in the current deadlock on Capitol Hill. Five years back, the total outstanding debt was $10 trillion, which has gone up by a whopping 67 percent in the last five years!

What is the impact?

Public services will be adversely impacted if the government shuts down. Parks and museums would be closed. No passports would be issued as passport offices would be closed. Many other non-essential public services too would be closed. But postal workers and food inspectors would work. Social security benefits, such as unemployment benefits and old-age/insurance benefits, too will continue to be paid as usual. Borrowing costs for the federal government would go up. Home values of the Americans would fall.

The possible shutdown may lead to a financial crisis threatening jobs and savings in the US. This may jeopardize US economic growth in particular and world growth in general. Failing to increase the debt limit would result in unimaginable consequences. Not paying debt obligations amounts to US default and this has not happened in recent history (Detroit city in the US filed for bankruptcy in July this year).

Financial markets seem to have ignored the shutdown impact for the time being. They may be basking in the positive news of the US Fed deferring its tapering decision. The markets would soon realize the ripple effects of the shutdown and may react violently depending on the outcomes from the US Congress.

What is the way-out?

There are some proposals on table, such as bringing a temporary funding bill and prioritizing the payment of obligations. At the time of writing this post, the discord over the budget remains. It is hoped better sense would prevail between the sparring parties. Nobody is sure how the impasse can be resolved in the next few days, if not weeks.  

To Sum Up:

If the shutdown is only for a few days, the impact may not be material. But if it is prolonged it will have huge negative effects, not only on the US economy but also across global financial markets, which are basically US-centric.

The US has been unable to balance its budget, but the world is still willing to pour money into the US thinking that the country would never default. Rampant government borrowing has resulted in an ocean of debt for the US.

Investors such as Jim Rogers and Marc Faber are highly critical of the US government’s efforts to flood the world with US dollars or fiat money. They have been arguing that the US has to implode at some point of time. The ongoing bitter fight on Capitol Hill has damaged the credibility of the US in the eyes of the world and if better sense does not prevail on the US lawmakers, it will lead to some tectonic movements across the globe. Investors are to brace themselves for increased volatility in the markets in the next one month until a settlement is in sight.

 Related: US Fed tapering postponed 19Sep2013

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References: www.treasury.gov, www.treasurydirect.gov

Picture: Capital Hill Building. Washington DC. Courtesy: www.aoc.gov

Disclaimer: The author is an investment analyst, equity investor and freelance writer. This write-up is for information purposes only and should not be taken as investment advice. Investors are advised to consult their financial advisor before taking any investment decisions. He blogs at:

http://ramakrishnavadlamudi.blogspot.in/

http://www.scribd.com/vrk100

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