Strategic Foresight


From shutdown crisis to default pandemonium?

11 Oct 2013 - 13:57
Source: NPCA Photos

A short history of shutdowns

The current US government shutdown isn't unique: there have been eighteen shutdowns since fiscal year (FY) 1977. Under President Clinton the most recent shutdown took place. In 1995/1996 federal employees had to deal with two shutdowns, one for a period of five days, the other took 21 days. After the closure ended in January, political stability didn't return immediately: in the first four months of the year, government was dependent on eight continuing resolutions (CRs) to keep agencies going. A CR is what Congress passes when they can't pass appropriation bills. The CRs started to become pretty common during the 2000s. In FY2001 Congress passed about 20 CRs!

Tea Party: negotiating or blackmailing?

Even if the Senate and House had come to an agreement, the federal government would have been running on a CR that would have expired on December 15 at the latest. But Speaker Boehner felt cornered by the Tea Party wing of his Grand Old Party (GOP: Republicans) and chose to not make a deal.

Since the rise of the Tea Party it's safe to speak of GOP vs GOP warfare. The ideologically driven, conservative base of the party has given Tea Party politicians the stamina to confront the moderate GOP leadership and not back down from fights that endanger the US economy and global reputation. The de facto  leader of the Tea Party movement, Senator Ted Cruz,  spoke for over 21 hours on the senate floor in an effort to prevent the Senate from funding Obamacare. The Economist described Cruz' course as ever-more-extreme-political-purity tests and conservative purity politics. When the time comes for the Republican presidential nomination contest in 2015/2016, Cruz will be able to make the case that he is the one and only true Republican.

Moderate Republican leaders feel threatened by the Tea Party. The leader of the GOP in the Senate, Mitch McConnell, faces a difficult re-election next year in his home state Kentucky. He is in danger of losing his seat to a Tea Party candidate. Therefore he feels forced to take a more uncompromising standpoint than he would like. The fine line between negotiating and extorting has become very blurred and it remains to be seen for how long the public will accept a line this blurred.

Real test still to come

The shutdown discussion set the stage for an even more nerve-racking deadline on October 17 when the US will cross their debt ceiling. The government could get by for at most another couple of weeks with $30bn cash on hand, but without a deal the US will in effect be in default at that time.

Republicans have tried  to tie delaying, defunding, and scaling back Obamacare (important parts of which have started being implemented this month) to raising the ceiling. Also they would like to load a debt limit bill with dozens of conservative priorities. But the last couple of days they seem to have realized that the Obamacare way will lead nowhere, so they have shown some signs of letting go of attacking the health care law.

However, the House on the one hand and Senate and White House on the other are still miles apart on reaching a deal. Most likely, Democratic and Republican lawmakers will pull the US away from the edge of the abyss, but this dangerous political drama will harm the domestic and global reputation of U.S. politics even more after, among other things, the NSA/Snowden/Prism affair, Congress' historically low approval ratings and the flip-flopping on Syria. Moreover, the parties will probably only offer a short term solution, which means the whole spectacle will start all over again within months, possibly even within weeks.

Some disturbing precedents

During the debt ceiling fight in 2011 consumer confidence took a serious hit, stock markets cratered, the US credit rating was downgraded, and hiring slowed. If we go a couple of decades further back, we find that the US defaulted in 1979. It was a technical default due to some clumsy mistakes and it only concerned $122m, but that translated into a loss of $12bn and according to some it has permanently raised the costs of government borrowing. In 1957, the Air Force stopped paying its bills due to the US hitting the debt ceiling. This amounted to $8bn less spent; the equivalent of 1.7% of GDP. Researchers claim this default was one of the main reasons for the recession of 1957/1958.

Worldwide chaos

If politicians can't reach a deal on time, the US can only spend as much as incoming revenues. That means a 20-40% reduction in government spending, which would tip America into recession even before accounting for the resulting financial chaos. Every week the Treasury rolls over $100bn in debt. If investors decide they just want their money back, this would result in interest rates rises that could nip the still vulnerable recovery in the bud.

People still think that even the Tea Party is adverse to being blamed for making the US a defaulter and according to scholars the law offers Obama a way out by just plainly ignoring the debt ceiling if Congress doesn't come to an agreement.

A default isn't inevitable, but the current unpredictable behavior of - in the words of one Democratic Representative - this Congress of Chaos will probably unnerve markets in the coming weeks. James MacKintosh wrote for the Financial Times: "Investors usually hope for the best from Washington until the last minute. Then they panic." Politico, a political journalism organization, spoke of a "touch-the-stove moment" when writing about the GOP's handling of the shutdown. The stove will be even hotter within two weeks and it remains to be seen if politicians are prepared to burn their hands even further. If the US defaults, financial markets worldwide will go into cardiac arrest, because markets are not set up to trade or finance defaulted Treasuries. The Atlantic calls "not raising the debt ceiling a crisis, if we're lucky, a historic calamity if we're not." Let's hope Washington will get to its senses and reach a deal before pandemonium starts.