Navigating the Storm: Understanding the Real Implications of the US Government Shutdown

Introduction

As the impending US government shutdown looms on the horizon, many may dismiss it as just another act in the political theater that has become a recurring spectacle in Washington. However, a closer examination reveals that this shutdown is not just theater; it carries significant implications for the nation’s fiscal health and political landscape, especially as we approach the 2024 election cycle.

A History of Shutdowns

Government shutdowns are not a new phenomenon. They have been a part of the American political landscape since the Carter and Reagan eras. While most of these shutdowns were short-lived, with the government quickly passing budgets to resume normal operations, the most recent one in late 2018 lasted a staggering 34 days. But why should we be concerned about the 2023 shutdown? To understand this, we need to delve into the rapidly worsening US fiscal position.

US Fiscal Position Is Worsening Rapidly

The most alarming signal emanating from the current government impasse is the steep deterioration of the US fiscal trajectory. Federal government interest payments as a share of federal government revenues, as illustrated in Figure 1, are on the brink of breaking historical records. Several factors contribute to this concerning trend:

1. Steep Interest Rate Increases: The pace of interest rate increases in recent times has been faster than in previous tightening cycles. This makes the burden of servicing the debt significantly heavier.
2. Rising Debt Burden: The overall increase in the debt burden means that interest rate risk has become more potent. Despite extending the average debt maturity to six years, a substantial volume of debt is being refinanced at today’s higher rates.
3. Persistent Fiscal Deficit: The US fiscal deficit remains surprisingly high at nearly 8% of GDP. This means that the issuance of new debt is not only substantial but also expensive.

Furthermore, tax revenues have underperformed, making the situation even more precarious. Projections for corporate earnings and wage growth do not offer much hope for a swift recovery in tax revenues. As a result, debt servicing costs are poised to continue their ascent, setting the stage for difficult political decisions.

Fiscal Austerity on the Horizon?

Historically, major deficit reduction measures have been enacted during times of divided government. Examples include the Reagan and Clinton budget deals, which occurred when debt servicing costs were historically high. Conversely, major tax cuts tend to be implemented during periods of low debt servicing costs and unified government.

The current weak fiscal position, combined with the impending 2024 election cycle, raises concerns about the ability to provide fiscal support in the event of an economic downturn. With a unified government appearing improbable, the prospects of significant deficit reduction, i.e., fiscal austerity, become more likely in 2025. This could have profound consequences for economic growth and stability.

Shutdown Puts Deficit Center Stage in US Elections

The government shutdown serves as the opening act for the upcoming US election season. It signals the return of fiscal deficits to the center stage of political debates. Even in a scenario where the Federal Reserve Board (Fed) implements rate cuts as part of a ‘soft landing,’ it may not be sufficient to counteract the structural drivers that constrain fiscal space, as outlined above.

Consequently, the Fed is likely to remain the key policy player in any economic downturn, as fiscal policy becomes increasingly congested and potentially serves as a headwind to US growth in the coming years. This dynamic underscores the importance of understanding the long-term implications of the current government shutdown beyond the immediate disruption it may cause.

Conclusion

In conclusion, the US government shutdown may appear as just another episode in the ongoing political drama, but it carries significant and far-reaching implications. The rapidly deteriorating fiscal position, the potential for fiscal austerity in the future, and the return of deficits to the forefront of political debates all make this shutdown more than just theater. As investors and citizens, it is essential to pay attention to these underlying economic and political trends and their potential impact on the nation’s financial stability and growth.