It should come as no surprise that our country finds itself in yet another internecine squabble regarding questions about how much to, or maybe even if we should, fund governmental operations. It is a source of national embarrassment that the United States hasn’t passed a full slate of Appropriation Bills since Fiscal Year (FY) 2008. Looking back to FY 1977, there have been 17 funding gaps of at least one day or more (Congressional Research Service). The funding gap in Fiscal Year 1997 was, until now, the most highly publicized funding gap. In FY 1997, the U.S. Government shut down from 15 December 1996 until 6 January 1997. While our current shutdown commands the attention of the vast majority of the press, the effects of a shutdown are mostly temporary; they do not extend much past the lost productivity of government workers. There may be very real impacts in specific sectors of the economy. Closed national parks may affects tourism related businesses, closed Headstart facilities would affect the working poor, and closed licensing authorities may affect whether businesses get certain permits or not. However, this could be balanced against the economic activity created by people who substitute their vacation dollars away from national parks or by depending on friends and family for daycare. Moreover, the impact of the shutdown will begin to be felt – even in these sorts of affected sectors – only if the shutdown drags on. Thus, it is hard for us to get overly excited about another crisis of artificial proportions.
The bigger issue associated with yet another game of brinksmanship played by two kids who can’t play nicely on the playground, is the issue of a possible link between this fight and the yet-to-be-had fight over raising the debt ceiling. Even without the current intervention by the Federal Reserve, the United States dollar enjoys reserve currency status, which allows the U.S. to borrow at very low interest rates. Certainly artificially low interest rates hurts U.S. savers, but it is a boon for the U.S. in terms of lessening the burden of servicing the fast-growing U.S. debt. Now, though, we are quickly approaching the date when all extraordinary financial measures will be exhausted and the U.S. will default on its legal obligations. This date is widely believed to be 17 Oct (side note – just approaching the debt-ceiling deadline in 2011 caused the U.S. to suffer a downgrade to its heretofore sterling credit rating; an actual default will potentially have long-lasting implications, as it will most likely raise borrowing costs substantially and it will make asset valuation harder because treasury bonds will not be risk free anymore), but the first large, default-inducing payment comes on the 1st of November when benefit checks are due. Currently there are no indications that countries are actually worried about a default; in fact, the yield on the 10-year U.S. Treasury bond closed unchanged on the first day of the shutdown, which suggests there isn’t any panic selling as of yet. But let’s do some back-of-the-envelope calculations to get an idea of what may transpire. As of 31 August 2013 (latest data available from Treasurydirect.gov), there is $16.7 trillion of total U.S. Treasury securities outstanding. The average interest rate now is 2.4 percent; this equals about $400 billion a year in interest payments. Assuming that a simultaneous credit rating downgrade and a limited default causes a one percentage point increase in the average interest rate from 2.4 percent to 3.4 percent (a rate last seen in August 2009), interest payments will increase by $170 billion a year. To put this in perspective, last year’s Fiscal Cliff deal is projected to raise $617 billion in new revenue over 10 years; all of this new revenue will be subsumed by increased interest payments in less than four years.
A less obvious but more pernicious consequence is the uncertainty that results from nearly five continuous years of partisan gridlock. Businesses and individuals cannot plan if they do not know whether a law will exist or not. This puts a damper on economic activity and job creation. Moreover, to the extent larger businesses have more resources to deal with uncertainty, partisan bickering serves as a tax on small job creating businesses.
— Commentary provided by me and Jeff Smith.