Quantcast

Your Simple Guide to What Happens If the Government Shuts Down Next Month

Forget Syria. A few weeks from now everyone will be talking about the yet another debt ceiling fight between the Congress and Obama administration. Republicans in Congress are threatening to shut down the government unless Obama agrees to defund his own signature health care program, the Affordable Care Act. There's zero chance that Obama will sign such a bill.

First let's make a distinction. A government shutdown and debt ceiling breach are not the same thing. During a government shutdown Social Security checks will not be mailed, government employees will be furloughed, parks and embassies will shut down, and contractors will not get paid. Perhaps it could be a close repeat of 1995, except that both parties will probably want to make a deal in less than a month. Clinton and Gingrich both had nerve that Obama and Boehner don't. A government shutdown, while painful for citizens and companies, will not bring about the country's default.

But a debt ceiling impasse, potentially, can result in U.S. default. Default — the kind that everyone is afraid of — only occurs if a government fails to pay interest or principal on its bond obligations. A failure to raise the debt ceiling would force the government to decide what payments it wants to prioritize with the available money. Because a U.S. default would be an unprecedented, market-shattering event compared to a "mere" government shutdown, the government would sooner stop Social Security checks from being mailed than stop paying the interest on the Treasuries. The U.S. not paying the interest on its debt is a more devastating development than the U.S. not paying its internal bills. Still, the failure to raise the debt ceiling will not automatically translate into U.S. default. Many economists believe that U.S. can't default on its debts, simply because U.S. has its own currency and is willing to print more of it.

Markets point to exactly that kind of sentiment. Normally, when markets expect a country or a company to default, they begin to sell its debt long before the actual default. Bond traders are a jumpy and a neurotic bunch, and any sovereign hiccup is a reason to short the country's debt, driving the yields higher. If and when the actual default comes, it's all over but the crying. It's all been priced in weeks and months before (sell on rumor, buy on the news, to paraphrase an old market maxim). A country that is having its government 10-year bond yield in the 2-3% range is nowhere near default.

While a threat of default is very real with our dysfunctional Congress, very few are under the illusion that a default would happen due to a real U.S. insolvency. It's not that the U.S. can't pay up, it's that the mechanism for sending the checks is broken. Apparently, this is enough for investors to be sanguine about U.S. debt.

We have been there before: During our last debt ceiling fight in 2011, while the markets tanked, the 10-year Treasury yield actually declined, signaling investors' increased interest in U.S. Treasuries. By August it firmly occupied a 2% handle, ranging from 2.77% to 2.07%. These are not the yields of a country on a brink of default. Interestingly enough, in 1995 during the shutdown, the Treasury yields also tightened: 10-year Treasury yield went down from 5.93% in November 1995 to 5.65% in January 1996, after having a 6% or 7% handle the entire year.

By contrast, here's what happens when the market really thinks things are about to hit the fan. Greece's 10-year bond yields reached an all-time high of 48% in March 2012. That's default territory. And yet even Spain and Italy's yields during the worst months of 2011-2012 never even reached a 10% threshold. Mind you, these are not even the countries that can print their own currency, unlike the U.S.

A Gingrich-like government shutdown would be too visible and too painful for the public to ignore. Only a third of respondents will blame Obama administration for the impasse, but 51% would point the finger straight at the GOP. Democrats, at least for now, are in the wait-and-see mode, perhaps waiting for Congressional Republicans to implode due to internal differences. The Democrats also think that the debt ceiling fight will give them more leverage when the nervous business community starts calling their congressional liaisons.

Both the shutdown threat and the debt ceiling debate do not need to happen. These are contrived, self-imposed problems that GOP created as a ploy to defund or repeal Obamacare. If the GOP thinks the possibility of default is real, it's stunning that such outcome is still perferable to them than admitting defeat on Obamacare. If they think there's no real possibility of default, then what's the point of this posturing? To teach U.S. citizens the evils of spending?

This promises to be an interesting fall.

Like us on Facebook:
CLOSE | X

Do you agree that our
generation needs a voice?

Take a One-Question Survey and Give Us Your Feedback.
Take the survey now