US funding fights: not the first and surely not the last

Economic opinion

Political confrontations related to fiscal spending in the US are constant, repetitive, and have damaging effects on the economy. The recent 35-day partial shutdown of the federal government, temporarily resolved by a three-week continuing resolution, is one such example. Though the US government has reopened, easing some of the hardship caused by the shutdown, uncertainty still lingers. US lawmakers and President Trump have until 15 February to agree on a bill that will fund the government through 30 September 2019. Staunch disagreement between the two parties, specifically regarding President Trump’s demand for border wall funding, will complicate the process. With very high political polarization in the US and a new debt-ceiling deadline looming in March, it is unlikely that we have seen the last of such political skirmishes.

Risks abound: now it’s government funding, next it’s the debt ceiling

US federal workers, among others, breathed a sigh of relief on Friday when lawmakers announced an agreement to fund the government for three weeks, ending the 35-day shutdown. Government shutdowns happen when Congress doesn’t pass the necessary bills or resolutions (signed by the president) to fully fund the government. Agencies without funding shutter non-essential services and stop paying employees until the government has reopened. Although the most recent closure was not the first such federal shutdown—the government has been shut down four times in the past seven years—it was the longest and appeared to be having a far more damaging effect.

Shutdowns are not the only budget-related confrontation in US politics. Debt ceiling crises in 2011 and 2013 have transformed the previously non-controversial routine of increasing the debt ceiling into a perpetual game of ‘chicken’. The debt ceiling is a self-imposed limit on the total amount of money the US government can borrow. It is currently suspended until 1 March 2019. On that date, the debt ceiling limit will be reset to whatever level the debt is at that moment. If no action is taken by Congress before 1 March to increase the debt limit, the US Treasury will not be able to issue new debt. Cash at hand and extraordinary measures will need to be used for the Treasury to continue financing the government and to avoid that the government defaults on its outstanding debt. Recent projections from the Bipartisan Policy Center estimate these measures will allow the Treasury to fund the government until at least mid-summer 2019 (also known as the X-date).

Political problem with economic consequences

Shutdowns and debt ceiling crises can have significant implications for the economy. Shutdowns hurt unpaid government workers and others who rely on government services, and they become more damaging to the economy and sentiment the longer they persist. The CBO estimates the direct nonrecoverable cost of the recent shutdown to the 2019 GDP level will be USD 3 billion (or 0.02% of GDP). This estimate does not incorporate negative indirect effects like businesses deciding to postpone investments and hiring.

Debt ceiling crises raise interest rates, increase financial market volatility, weigh on confidence, and damage the reputation of US debt as a ‘risk-free’ asset. Increased uncertainty and tighter financial conditions in the US can have spillover effects globally and can especially weigh on growth in emerging markets. Independent of the specific cause, a slowdown in the domestic US economy will also impact other countries via declining US import demand and lower US investments abroad.

Meanwhile, Congress failed to pass a spending bill in time to avoid the government closing due to an ideological fight centred around President Trump’s insistence on building a wall on the southern US border. Though President Trump backed down on his demand for a ‘down payment’ on the wall in any temporary funding resolution, he has not backed down on his demand for wall funding in general, suggesting that another shutdown is possible if he doesn’t get said funding. Hence, the functioning of the US government is being used as a bargaining chip for political ends. So, while the current budget confrontation is not economic in nature, the consequences for the economy are very real.

With the issues behind the shutdown still unresolved, a looming debt ceiling debacle is also fast approaching. US government debt reached 104% of GDP in Q3 2018 and is projected to continue rising, which raises questions about debt sustainability in the US. But just as the shutdown was not about budgetary disagreements, fights over the debt ceiling are not really about debt sustainability. The policy decisions about spending, and therefore government debt, should be made just through separate spending resolutions (i.e. what Congress now needs to pass). Voting to raise or suspend the debt ceiling so that those spending resolutions can be realized is a superfluous and now risky step in the budget process. While the debt ceiling has its merits as a reminder to Congress to keep spending in check, it is more and more becoming a liability because it is increasingly used as leverage to push political agendas. This happened in both 2011 and 2013 when the debt ceiling was reached, and US politics turned into hostage-like situations.

We have argued previously (Economic Opinion 15 September 2017) that it would be wise to abolish the debt ceiling altogether as it does nothing more than create additional periodic uncertainty by putting the solvency of the US government at risk without meaningfully contributing to federal debt sustainability. US Democratic lawmakers share the view that the debt ceiling is redundant and have reintroduce what is known as the Gephardt rule within the House of Representative to reflect this. Specifically, the debt ceiling will be automatically lifted when the House passes a budget. The Senate and president, however, would still have to approve the budget and debt limit increase as well, only partially solving the problem.

Outlook shaky

As we wrote in November following the US midterm elections (Economic Opinion 7 November 2018), a divided Congress, while unlikely to achieve anything substantial on the legislative front, could still rock the global economy going forward. Indeed, the still unresolved border-funding conflict can now be added to a formidable list of factors that are stirring uncertainty about the global economic outlook.

If a comprehensive agreement to fund the government is reached soon, the upcoming debt ceiling issue will likely become less concerning. The Gephardt rule in the House would imply that at least one of the three necessary parties (the House, the Senate, and the president) will have approved the debt ceiling increase well ahead of the mid-summer ‘X-date’. One could also imagine that budget-related showdown fatigue would prompt politicians to think twice about using the debt-ceiling as a bargaining chip so soon after trying something similar with the shutdown. The fact that President Trump eventually agreed to fund the government without any border wall money indicates that he is not entirely insensitive to declining approval ratings.

At the same time, President Trump continues to break political norms, and political polarization in the US is as strong as ever. Failure to agree on a comprehensive budget will complicate the need to raise the debt ceiling. If politicians were still unable to come to an agreement on the debt ceiling before the Treasury’s resources dried-up, and the US were to default on its debt, the implications for the global economy would be severe. Furthermore, even if the budget and debt ceiling issues are resolved in a timely matter, they will inevitably return, especially when funding for fiscal year 2020 needs to be appropriated. With many political eyes on the 2020 election, a smooth, bipartisan process is anything but likely.

Disclaimer:

Any opinion expressed in this KBC Economic Opinions represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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