Economic Commentary: The Shutdown and the Debt Ceiling

Government Shutdown and Debt Ceiling

There are plenty of people predicting that the government shutdown and crossing the debt ceiling deadline will spell disaster for the U.S. economy and potentially the global economy.  We want to be very clear in stating that we do not see such a disaster as evenly remotely possible.

Each element – the shutdown and the debt ceiling deadline – needs to be analyzed separately in order to understand what the true affects will be.  In providing these insights, we are steering clear of any political discussion and are not expressing any opinion whatsoever about who started this.  We have political differences within our own office, just as there are in the country as a whole.  Our only objective here is to provide honest, objective advice on what the economic affects of the current stalemate will be.

First, the shutdown.  It’s important to keep in mind that this isn’t a shut down.  It is a slim down.  The government is still spending money; it’s just spending less.  Secondarily, it’s instructive to remember that the sequester did not destroy the economy.  There were plenty of predictions to the contrary, but we went into it, and the economy continued to improve.  Here’s why.

Government payments are, in all cases, a transfer of money from one person to another.  In order for the government to pay a federal employee or a vendor, it must take the money from a taxpayer or from someone who voluntarily lends it by buying a government bond.  The federal worker or vendor spends the money they receive, and that helps the local economy (wherever it is), but the person who is taxed, or who lends the money to the government, has less money to spend in his or her local economy.  The gain in one local economy is offset by the loss in the other local economy.  The nation, as a whole, is not better off as a result of government spending.

The same analysis works in reverse.  If the government stops spending money (the sequester or the shutdown), one local economy is hurt (wherever the employee or vendor would have spent the money), but another local economy is better off.  When the government decreases its spending, there is a taxpayer or investor who now has money to spend somewhere else.  That local economy will be better off.  The nation, as a whole, is not worse off as a result of reduced government spending.

For example, if the government does not sell bonds to China (China being one of the biggest buyers of Treasury Bonds) to fund some government department – say the Commerce Department where 86% of employees are furloughed – then China will need to find something else to do with that money.  Maybe China will buy corporate bonds, or stocks or Boeing aircraft.  In other words, the shutdown allows money that would have been diverted to the government to be kept in the private sector.

Next, the debt ceiling deadline.  Crossing the debt ceiling deadline simply means that the US government will not be able to borrow more money.  That does not mean that interest payments or principal payments would necessarily be terminated.  The federal government still takes in more than enough revenue to pay the interest on the debt. In October, federal receipts will be $200 billion, while interest owed on the debt is $25 billion. Principal can be repaid by rolling over the maturing debt.  In other words, any “default” would be a political choice, not an economic necessity by any stretch of the imagination.

But, let’s assume for a moment that the Treasury Department made the decision not pay interest or to miss a principal payment.  The US would at that moment be “in default” on that payment.  What happens, though, when the government later makes up that missed payment?  The debt no longer is in default, and the government will have been late in making a payment, but it will not have failed to make the payment.  The distinction is not just semantic.  Being late and actually defaulting on debt are two different things.  Again, we won’t comment on the politics here, but there is no reality we can contemplate in which our interest and/or principal payments will not be made at some point.

On a positive note, and more importantly for investors, all of this political wrangling can be viewed as very good news. Politicians are dealing with what everyone knows is a long-term fiscal problem.  Yes, the political wrangling is intense, but there are some significant systemic issues surrounding spending vs revenues that have to be dealt with.  Such deep political issues have never been settled in squeaky clean, white-glove conversations in any country at any time in history.  They’ve always resulted in political brawls.  The important thing is we may actually be getting around to dealing with it now, before it becomes a Detroit-like problem for the US. In the end, this is the best news of all and it bodes well for the long-term direction of the United States.

Lastly, the affect on the markets.  Given the dire predictions we’ve heard, you would have expected stock markets to be terrified.  They aren’t so far.  Less than one month ago, the Dow hit an all-time high of 15,676.  It has sold off a bit since then (about 6%), but this isn’t the mark of panic.  There are several reasons.  First, the likelihood of a true default are slim to none as described above.  Second, in previous government “shut downs” (there have been 18 of them since 1975), furloughed workers were given back pay after the stalemate was broken.  The current Congress has already voted to provide back pay to furloughed workers.  Lastly, there will be an eventual political solution.

This doesn’t mean the road won’t be rocky.  It will be.  There may even be additional sell offs as fear and uncertainty continues.  The market will always try to figure out who the winners and who the losers will be – is it defense contractors or appliance manufacturers? – and when there is uncertainty, markets hedge a bit.  Even an additional 10% or 20% sell off wouldn’t be  a reason to panic.  We’re not predicting that, just stating that such a drop wouldn’t be a sign of impending disaster.  The bottom line remains, the economy is still growing, strong companies are still strong companies, and their stocks will reflect that in the long term.

“The art of economics consists in looking not merely at the consequences of policy for one group, but for all groups.” Henry Hazli

Understanding Annuities

Financial Guide


Recent Posts

Ready to Talk?

Let’s schedule a time to learn about your needs and retirement plans.

Ready to Talk?

Let’s schedule a time to learn about your needs and retirement plans.


Download our

Financial Planning Guides

Understanding Annuities

We are committed to helping families make wise decisions among all the competing priorities they face.

Saving for College

The sooner you start saving for college, the better positioned you will be to greet that big day with enthusiasm, not dread.

Preparing for Retirement

Retirement should be as active and rewarding, and you shouldn’t have to worry about your situation.