US shutdown no big deal, expect bigger crisis on 17 October

platinum_coinVivek Kaul

 Starting today nearly 800,000 of the 2.1 million people that work directly for the government of the United States of America, have been asked to go on an unpaid leave, leading to non essential services from national parks to museums to libraries being shut down temporarily. The call centres of the Internal Revenue Service(IRS or the equivalent of the income tax department in India) won’t work and nearly 90% of the workers of the Environmental Protection Agency, won’t be at work either. NASA or the National Aeronautics and Space Administration has also more or less been shut down, except its mission control centre at Houston, Texas. Services like rubbish collection and street cleaning stand suspended as well.
Nearly a million workers have been asked to work without pay. This will ensure the continuation of essential services like military, postal service and police. Airport security and air traffic control will also carry on their work as usual.
So what is happening here? The US budget year ends on September 30 every year. A ‘shutdown’ comes into the picture when the American Congress (the equivalent of what we call the Parliament in India) does not pass appropriation bills to fund the ‘discretionary’ spending programmes. The discretionary spending programmes need to be funded every year.
As Matthew Yglesias writes on www.slate.com “Discretionary spending…is money that Congress appropriates on what’s traditionally been an annual cycle. A law is passed saying that such-and-such agency has X amount of money to spend over such-and-such amount of time on this or that.” What is not categorised as discretionary spending is ‘mandatory’ spending. This includes social security, medicare (a form of medical insurance) and some farm subsidies. This spending continues as usual.
The two houses of the American Congress are currently in a logjam. The House of Representatives is dominated by the Republican Party and the Senate is dominated by the Democratic Party. The Republicans want the Affordable Care Act (better known as Obamacare, and an Act which aims to improve the quality of health insurance, at the same time making it more affordable ) to be pushed forward by a period of one year. They have made this a condition for passing a temporary budget to fund the ‘discretionary’ spending of government.
The Democrats on the other hand are in no mood to relent given that the Affordable Care Act is something that President Barack Obama has been closely associated with. Hence, the two political parties have been at loggerheads. As Yglesias writes “When the parties in Congress can’t come together on appropriations bills, they often pass what’s known as a continuing resolution that essentially instructs the government to extend the last appropriations bill forward in time…House Republicans keep writing new continuing resolutions that fund the government while simultaneously delaying or repealing key elements of the Affordable Care Act. Senate Democrats keep taking those provisions out and sending the “clean” continuing resolution back to the House. Absent a continuing resolution, the discretionary portions of the federal government lack funding to continue their work and the government goes into “shutdown.””
With no money coming in the non-essential services are being shutdown. As The New York Times reports “The Office of Management and Budget issued orders that “agencies should now execute plans for an orderly shutdown due to the absence of appropriations” because Congress had failed to act to keep the federal government financed.”
The shutdown will impact the American economy depending on how long it continues. Estimates made Goldman Sachs suggest that a two day shutdown could slowdown the economic growth rate during the period October-December 2013 by 0.1%. A longer shutdown of a week could shave of 0.3% from the economic growth.
Nevertheless, the American government partially shutting down should not be seen as a big worry. The bigger worry is set to come on October 17, later this month. On that day the American government is expected to hit its debt ceiling. The American government spends more than what it earns. In order to make up for the difference it sells bonds and takes on debt. There is a maximum amount of debt that it is allowed to take on, and which currently stands at $16.69 trillion. This limit is likely to be exhausted by October 17, 2013.
If the debt ceiling is not raised the American government will have to stop borrowing and start cutting its expenditure. AsEric Posner writes on Slate.com “If the debt ceiling is not raised, and the executive branch stops borrowing, the government will need to cut spending by about 15 to 20 percent—or almost 40 percent of spending on everything (yes, Medicare and defense) other than the interest on the debt.”
The impact of the cut in expenditure will be immediate. As Henry J Aaron writes in The New York Times “A decision to cut spending enough to avoid borrowing would instantaneously slash outlays by approximately $600 billion a year. Cutting payments to veterans, Social Security benefits and interest on the national debt by half would just about do the job. But such cuts would not only illegally betray promises to veterans, the elderly and disabled and bondholders.”
Also, the American government has reached a stage where it pays the interest on past debt by selling new bonds and taking on more debt. Any decision to stop paying interest on bonds will lead to a global financial crisis. As Posner writes “ If he(i.e Obama) stops interest payments, the United States will default. This will not only raise interest payments—costing taxpayers hundreds of billions of dollars—but could spark a financial panic like the meltdown of 2008.”
If this situation arises, there is not much that President Obama will be able to do. He will basically have three options. “One is President Obama could decide that the government’s legal obligation to spend (and certain elements of the 14thAmendment) trump the statutory debt ceiling, and just order the Treasury to sell more bonds. The second option is Obama could instruct the Treasury to pay some of the government’s bills and just not pay the rest. The third option is to pay nobody. All three of these options face the same basic problem of seeming to be illegal. (The second one also faces the problem that Treasury says it lacks the logistical capacity to do it),” writes Yglesias.
Also, there are no legal provisions to decide which expenditure should be cut first. “There is no clear legal basis for deciding what programs to cut. Defense contractors, or Medicare payments to doctors? Education grants, or the F.B.I.? Endless litigation would follow. No matter how the cuts might be distributed, they would, if sustained for more than a very brief period, kill the economic recovery and cause unemployment to return quickly to double digits,” Aaron points out.
Given this, the Republicans and the Democrats need to start talking pretty soon, or we will have another crisis on our hands pretty soon.

The article originally appeared on www.firstpost.com on October 1, 2013

 (Vivek Kaul is a writer. He tweets @kaul_vivek)

 

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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