The Independent Market Observer

10/17/13 – Assessing the Damage

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Oct 17, 2013 10:04:09 AM

and tagged Politics and the Economy

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“Pro football is like nuclear warfare. There are no winners, only survivors.” — Frank Gifford

That pretty much sums up my take on the most recent confrontation in Washington, DC. No one won, and everyone lost. The Republicans took a huge poll and public relations hit, for no gain at all. The Democrats didn’t lose as much but, in many ways, came out looking just as petty and political. Congress has hit all-time lows in public support, something I would have said was almost impossible, and the White House has been roundly and justly lambasted for its lack of leadership.

There was one more thing . . . oh, yes, the country, which seems to have been among the last things on the minds of our representatives. The damage has been real, and it may end up being substantial.

Not only that, we haven’t really solved the problem, merely agreed to create additional uncertainty and angst for the next several months. While there won’t be an immediate crash, we’re almost guaranteed a steady stream of debate, invective, and uncertainty, which will quite possibly undermine the economy for the next quarter. Consider the fourth quarter of last year, when uncertainty created by the endless coverage of the fiscal cliff helped drag economic growth to zero.

I don’t actually expect the damage to be that severe this time. We headed into the confrontation growing at around 2.5 percent. The shutdown itself will knock off about 0.5 percent of growth, leaving us at around 2 percent—bearing in mind, of course, that these numbers are only educated guesses. With consumer confidence declining, business confidence surveys down, and initial jobless claims up, the standoff already seems to have created a chilling effect. While the current deal will mitigate that, it won’t eliminate it. We will probably grow this quarter, but growth will be below what it could have been. The next couple of quarters will likely be adversely affected as well, with the template, again, being the zero growth at the end of last year and the slow growth at the start of this year.

With all that said, let’s take a look at where we actually stand now. The important points are as follows:

  1. The government has reopened, through January 15. The drag from the shutdown is therefore over, and much of it will be recouped as back wages are paid to federal employees when they return to work.
  2. The debt ceiling has been extended to February 7, formally, and well beyond that informally. I say this because the Treasury has retained the right to use the “usual extraordinary measures” the next time we hit the ceiling, which will buy additional months if they can be fully reloaded before February 7—which will probably happen. The other factor that will extend the time frame is that the government will go into fiscal surplus in a big way in April, when most of the tax receipts come in. The combination of the two effectively removes the debt ceiling from the equation, very probably, until later next year.
  3. A framework has been set for a negotiated settlement between parties.

Point 2 is the big one here. By removing the debt ceiling from the equation for quite a while, we will probably avoid another round of the angst we just went through, regardless of the negotiations. This is an unmitigated good and should, to some extent, buffer the economy from the uncertainty-related damage I mentioned earlier.

Point 1 is also significant, in that it reduces the sense of uncertainty and emergency created by constant reports on the shutdown. It also reinstates things like loan approvals, export guarantees, and economic data that help move the economy along.

Point 3, unfortunately, is probably the least significant. No framework is needed if people are actually willing to work together, and no framework is sufficient if they aren’t. The real question here is whether the Ted Cruz wing of the Republican Party will now be willing to work within the system, or whether they will continue trying to blow it up from the inside.

So far, the signs don’t look good, based on Cruz’s quotes and the reactions of some House Republicans, so we’ll no doubt be revisiting this again. The good news is that the structure of the deal at least buys us quite a bit of time on the most damaging component, the debt ceiling. Plus, the more mainstream arm of the Republican Party is now alive to the potential damage they’d face from a similar confrontation next year, close to the midterm elections. In the short term, therefore, I doubt we will be dealing with this again for a while. As good news, I’ll take what I can get.

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