Shutdown, Default and the Markets

I’ll keep this post as brief as I can.  (Jim, in 10,000 words or less, is it true you are verbose?)

The history of government shutdowns suggests they have little short-term effect, and no long-term effect, on financial markets.  The stock market decline to date is larger than during most prior shutdowns.  Historical precedent suggests this is more likely to be a buying opportunity than the trigger for a massive selloff.

A default would be another matter, and there has been much loose talk of the possibility of default if Congress does not raise the debt limit by October 17.  But the only way a default happens is if the Obama administration chooses it as an intentional strategy, for political purposes.

We do not run out of money on October 17, we run out of new borrowing authority. The government will still collect taxes, which are vastly larger than debt service costs. The 14th Amendment requires that public debts be paid — the debt comes first. So the United States will default only if Treasury Secretary Jack Lew chooses to spend tax revenues on something other than debt service. (More barriers around National Monuments?) Further, the Federal Reserve holds trillions of dollars of Federal debt, and is explicitly prepared to forego all interest and principal payments to avoid default.

So the U. S. will default only if Obama chooses, which he will not. He will use the threat of default to try to steer public opinion his way, in service of his policy goals.  Just as the Republicans will refuse to raise the debt ceiling, in support of their policy goals, with an eye on public opinion.

One man’s prediction.

5 thoughts on “Shutdown, Default and the Markets

  1. As you say, there will be no bond default unless Obama wants one. The Gov’t spent $14Billion/day (210 workdays a year) on average in 2013, of which $9Billion came from tax and other revenues and fully $5Billion per workday was raised by issuing new debt. Debt service in October will tend to be about $600Million per workday, although its average is more like $1.6Billion per day averaged over the whole year.

    So the Gov’t is taking in $9Billion/workday in tax revenue on average, and spending “only” $1.6Billion/workday on debt service, averaged over the whole year.

    But the big impact of running out of money is the Gov’t does go from spending $14Billion/workday to spending $9Billion/workday. $5Billion/workday will NOT be distributed, whether it is to bondholders, social security recipients, soldiers, air traffic controllers, TSA airport searchers, federal courts, or whatever. The essence of running out of money, running up against the debt limit is that all these things that the federal government is legally allowed to spend money on, even in a shutdown government, fully one out of three of those things will not get money paid after the government runs out of cash.

    If the Government continues to spend money as it is RIGHT now, with a sequester, with a “shutdown,” the Government will be out of money on around October 26. Which means that on or about that date, fully one out of three things the government is spending money on today will not be paid. One out of three soldiers? One out of three seniors getting social security? One out of three TSA agents (we can only hope)? Its hard to know what will be cut, no one will say ahead of time.

    But the good news is the debt can be serviced with ongoing revenues, and still leave enough money to pay for 2/3 of a “shutdown” government!

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    • I think you just made the Republicans point for them. Per your numbers, we are borrowing one dollar out of three that we spend. Pretty obvious this is not a sustainable policy. When will we fix it? Per Obama and the Senate, we will not.

      What is the Republicans position on this? They will fund all the operations of the government, but not Obamacare. They have sent bills to that effect to the Senate. The Senate says no way, Obamacare must be funded or no cancer treatments, TSA screeners, whatever. So the failure to fund the functions you mention is, pretty clearly, the fault of the Senate as fully as of the House.

      But if there will be no default, then why threaten it? To ratchet up the tension, and avoid talking about things for which majority support does not exist. Specifically Obamacare.

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      • To the extent the Republicans’ case that not extending the debt limit is not actually forcing the government to default on bonds, yes I conclude the Republicans are right. I don’t think it is surprising to learn that I look for facts and reach conclusions based on them irrespective of whos ox is being Gored (or Bushed for that matter).

        No action by congress WILL cause the US to “default” on some of its obligations, if not to bondholders then to social security recipients or VA doctors or soldiers or contractors or somebody. Everything the Gov’t is doing is because Congress has appropriated money to do it. Every penny of revenue it has follows Congressional action too. In the absence of any further action, Congress leaves the executive branch with something like 3/4 of the funding that it needs to do the stuff Congress has told it to do.

        So it IS Congress’ “fault.” Can it be isolated to the Democrats or the Republicans? No, it is just hardball, being played legally, with the teams chosen by the American People.

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      • I’ll just echo my reply to the other comment. What they are arguing about is appropriating money for a program only one party supported. So it isn’t the case that Republicans “bought” something and won’t pay for it later on. Further, Republicans have passed bills to fund pretty much all the rest of the government’s operations. Let Obamacare go, and the rest of everything is paid for. So Congress alone is structurally responsible for the lack of funding, and both houses of Congress have dug in their heels for their preferred policy.

        The ultimate solution to this type of impasse is for voters to definitively choose one party, and one cluster of policies. I continue to believe that, in the absence of that type of definitive electoral mandate (which would inevitably bring members of the opposite party across the aisle), it was terribly unwise for the Democrats to have rammed Obamacare through.

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  2. I could not agree more. I think Obama will blink and allow a deal to be structured. However, I doubt a long term solution will be reached until after the next presidential election, unless the Dems win a majority in the House.

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