US shutdown stokes fears of a looming default

This article appeared originally in Gulf News: link to original article

In the entire history of the US, there were a total of 17 shutdowns with the last one taking place between December 1995 and January 1996. The reason behind the current shutdown is that the Republicans are asking for a delay on Obamacare reforms in exchange for lifting the debt ceiling, which the Democrats are not accepting.

Therefore, and because the government will soon run out of cash as it reached its debt ceiling, there was no choice but to close down entities that it can do without. The shutdown has affected 800,000 out of more than 2 million federal workers, including 50 per cent of the Pentagon staff, and those at the national parks, research centres and elsewhere.

On the other hand, agencies and programmes that are independent in terms of funding will stay operational. These include Social Security (with delays in payments of course), the postal service and passport applications. Also, air-traffic controllers, prison guards (obviously) and border patrol agents can still report to work.

At the centre of this mess is the Healthcare Law, which hasn’t been suspended by the way because its funding has been sorted out earlier. That is, the Law has already allowed people to start signing up for insurance, with more than 2.8 million visiting the portal since the midnight of October 1.

Some are counting on the failure of this Law, though initial numbers seem to show signs of acceptance and cooperation, even if that was to avoid being penalised. However, and to be fair, a better judgement of the number of people signing up for the nationwide health insurance could be better assessed by two signposts _ in December, when insurance plans start coverage, and in March, when enrolments will be closed.


And if the government is paying subsidies for people who cannot afford full premium, then why not sign up? Since they can’t count on the plan failing, they decided to shut the government down. When the last shutdown took place, the total estimated cost was $1.5 billion (estimated at $2.1 billion in today’s money). For the current shutdown, the research firm IHS estimates a cost of $300 million (Dh1.1 billion) per day.

The question you should ask yourself is: why would the US incur such costs when it should be saving on unpaid salaries? Well, for one, an estimated $200 million of daily spending will be lost in the Washington DC area (a direct result of those sent back home),

Second, a retroactive back pay was paid earlier and which might have to be paid later and, three, a long lasting damage to the dollar’s credibility. As the main producer for the world’s main reserve currency, the US enjoys much lower borrowing rates than the rest of the world. Consequently, Americans also enjoy lower borrowing rates than consumers and businesses elsewhere.

It’s estimated that the advantage of printing the dollars, and the consequent lower borrowing rates, result in savings of $1,000 billion for the US. If the US government shuts down and then defaults, the result might not be a direct “dump the dollar and run” but rather a great loss of faith in the greenback. And with time, whatever remains of its worth would probably erode, giving the floor to other barely mature currencies to assume the big fat role and enjoy all the benefits.

Interest rates

In the last shutdown, the Fed slashed interest rates to get the economy going again, which resulted in a decent rebound of markets. Though how much further can the Fed lower the current close to zero rates? And to add to the US’ troubles, the deficit in its budget, as tax returns do not cover all spending, has ballooned.

This is not all; the high pension costs which have been deferred by the states and the newly introduced health care law costs will only make things worse. If a default is avoided, the US will need to reconsider all spending channels which it could afford to avail the full benefits of printing the dollar.

Think about it; if entities could be shut down and people are sent back home without a major setback in governments’ operations, doesn’t that imply inefficient spending and unnecessary hiring of people for the sake of reducing unemployment rates?

Now the last thought that I want to leave you with is this: if the Fed announcement of a possible tapering to its quantitative mechanism programme (which it has backed off from for now) could cause so much damage to emerging markets and dollar’s credibility, what would a US government default lead to?

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