The financial markets have largely shrugged off the first week of a partial U.S. government shutdown. While an upcoming U.S. debt default would be far more catastrophic for the economy, experts believe such a crisis will be averted.
U.S. stocks ended last week modestly lower, a pleasant surprise considering that more than 800,000 federal workers are still on furlough and a debt default isn’t entirely out of the question.
Experts agree that not raising the debt ceiling would have far more serious ramifications. If Congress doesn’t reach an agreement by Oct. 17, America would quickly run out of cash to pay its bills, and default on its debt. The consequences of that would include skyrocketing interest rates, Social Security funding issues, collapse of the money markets, and devaluation of U.S. dollar leading to destabilization of the global economy.
“There might be a financial crisis and recession that could echo the events of 2008 or worse,” states a report by the U.S. Treasury.
In short, don’t expect it to happen.
One reason for the relatively optimistic mood on Wall Street is that unless the political impasse enters complete paralysis, the current standoff will soon pass. Its effects are unlikely to affect growth of the real economy, which has been solid.
“With the increased likelihood that a shutdown could extend past mid-month when the Treasury has exhausted the last of its extraordinary measures to stay within the debt ceiling, the direct effects on real GDP will likely have exceeded 0.3 percent,” Citigroup chief U.S. economist Robert DiClemente wrote in a note to clients on Oct. 4.
“Past experience suggests that any second-order effects [on the private economy] are very limited and we don’t think this period is an exception,” DiClemente added.
Due to the government shutdown, the Labor Department did not release September employment figures on Oct. 4, but the Brookings Institution estimates that unemployment rate in September would have been 7.2 percent. That would be a 0.1 percent decrease from July, and a whopping 0.8 percent decrease from last August.
The biggest threat, it seems, is a possible dent to consumer confidence due to fatalistic media coverage and political fear mongering. Consumer spending accounts for more than half of the U.S. GDP, and it will be closely monitored heading into the all-important holiday shopping season.
A Cause to Unite?
House Speaker Rep. John Boehner (R-Ohio) publicly stated last week that he would not allow the U.S. government to default on its debt.
Democrats and Republicans agree that the debt ceiling would be raised, but disagree as to how to do it. President Barack Obama stated last week that he would not negotiate on the budget and raising the debt ceiling, while Republicans are asking for concessions. “We should look for some significant structural plan to reduce government spending,” Rep. Ted Cruz (R-Texas) said on CNN’s “State of the Union” Sunday.
Boehner must balance the demands of multiple factions within the GOP with the interests of the nation. But one thing is clear: a debt default will be a black eye for everyone involved.
The government shutdown, incidentally, also validated the Federal Reserve’s decision last month not to reduce its monthly bond purchases, dubbed quantitative easing (QE3).
“Our estimate is that each week of the shutdown reduces quarterly GDP growth by approximately one-tenth in the initial phase, but this drag intensifies toward two-tenths if the shutdown lingers into a third or fourth week,” wrote Deutsche Bank in a research note last week.
The longer the government shutdown drags on, the more U.S. GDP would be revised downward. In other words, it would prevent the Fed from tapering its asset purchases this year.
‘It’s Basically Theatrics’
Most market participants expect a debt ceiling deal to be reached this month, avoiding a default on government securities.
BlackRock Inc. CEO Larry Fink and PIMCO’s co-chief investment officer and “bond king” Bill Gross expect the Washington infighting to soon end.
When asked whether he believes the United States could default, Gross said at panel discussion broadcast by CNBC: “Our central bank is the central banks’ banker. ... I think it’s basically theatrics.”
The collateral damage on the U.S. economy, the stock markets, and Americans’ retirement savings and investment accounts would be too great for anyone to think about defaulting. “I think the most important thing we must understand is, the U.S. is the standard bearer of the world. People look to the United States as a country that lives by principles. And just the notion and just the conversation of a potential default is just unacceptable,” Fink said at the same panel.
New York-based BlackRock is the world’s largest asset manager with around $3.9 trillion in assets under management (AUM). With $251 billion in AUM, PIMCO’s Total Return Fund is the biggest bond fund in the world.
Even if default worries don’t subside, investors can trade on volatility. The CBOE Volatility Index (VIX), sometimes called the fear gauge, ended last Friday at 16.7. During the 2011 debt ceiling worries, VIX peaked at around 48. Investors can gain exposure via the iPath S&P 500 VIX ETF (NYSE: VXX), or VelocityShares 2x VIX (NYSE: TVIX) for more leverage.
The price to insure against a U.S. default increased last Friday. Price of five-year credit default swaps on U.S. sovereign debt increased 9 basis points to 46 basis points (1 basis point is 0.01 percent), according to DTCC data via Bloomberg.
Frank Yu is a contributor to the Epoch Times.
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