October 3, 2013

Government Shutdown NOT Default is the Issue.


Recently I had the opportunity to hear Robert Stein, the Deputy Chief Economist, of First Trust Advisors L.P. a financial services firm, give a speech on the situation we face in Washington D. C. Immediately prior to joining First Trust; Mr. Stein was Assistant Secretary for Economic Policy at the U.S. Treasury Department. Prior to that position he was chief economist for the Senate Budget Committee on Capitol Hill and an economist for the Senate Banking Committee and Joint Economic Committee. Suffice it to say that he understands Washington D. C. and the players involved in the battle over US Fiscal Policy.  And as Mr. Stein pointed out this debate is over two separate issues.  Should the government be allowed to shut down if the House of Representatives and the Senate cannot come to an agreement on the budget?  This is not the same as the debate over whether or not the United States should pay our bills and go into default on our debt.  But because the timeline for these two issues has come so perilously close together, shutdown and default have now been linked together in our minds as if they are one issue.  That could not be further from the truth.    

The truth is a government shutdown would have all non-essential personnel laid off for some period of time.  If, like in 1996, the shutdown was for a shorter two week period of time starting on October 1st, we would likely see a decrease in GDP of roughly .3% (Macroeconomic Advisers, 2013) 

If you needed to get your passport let’s say during this time frame, you’d be out of luck.  If though, you are expecting your Social Security Check not to worry.  It seems the legal view on Social Security is that checks are written from the trust fund and not from discretionary government funds. Therefore a government shutdown would not affect Social Security payments.  The same holds true for Medicare and its payments. (Macroeconomic Advisers, 2013)

The real losses can be expected to come from the compensation to Civilian defense works and Non-defense Federal employees.  After the sequester action and its consequential furloughs this will be an additional drag on GDP.  If these employees are not getting paid, and have no way to increase their hours worked to make up for the lost compensation, than that is just fuel that the economy will have to forgo.  And that my friend could mean a real drag to growth here in the USA.  We are still a 70% consumer society.  We need the growth in incomes to be put to use in our economy.  At its core, the economy is made up of transactions.  If the Leadership of this country wants job growth, why are they doing things they know will ultimately destroy demand?  If we don’t have demand for more goods and services, then there is no need to add additional staff to your business to service your customers.

Looking back to the government shutdown in 1996 federal workers were eventually paid for the time they lost.  If this were the situation in the government shutdown this time, then it would likely have little effect on personal consumption and demand.  It would really have been just an adjustment to government services not purchased during the time the shutdown occurred.  That means that the .3% of GDP lost in Q4 2013 would be back into the Q1 2014 GDP numbers. (Macroeconomic Advisers, 2013)

The Default discussion around the debt ceiling is different altogether.  No one wants to see the United States Default on its Debt.  That would have massive repercussions on the interest expense that the government has to pay on any future debt it would incur.  That would not serve anyone’s political agenda for the mid-term 2014 elections.  So therefore, I believe this to be a highly unlikely outcome.  A short (two week) government shutdown while cutting growth estimates for GDP in Q4 of 2013, is unlikely to have a prolonged effect on the economy. The psychological effect on our society though remains to be seen.  As James Madison once said, “The circulation of confidence is better than the circulation of money.”

We need leadership that can instill confidence.  Not make us all want to stuff our mattresses. The real casualty of this Fiscal Fight is investor’s emotional response to the lack of confidence in the people who govern us.  Because of that emotion investors can be tempted to make decisions with their money that will hurt their long- term growth much more than a government shutdown might actually hurt long-term earnings expectations for companies. While this makes it tough for investors to stick with their investment strategy that is exactly the right course. A far bigger mistake in my opinion is for investors to make long-term decisions on short-term issues. 

By:  Angela Bender

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