Fortnightly insight into the current state of the economy and how it relates to Dorset
by Nigel F Jump, Chief Economist of Strategic Economics Ltd (a Dorset Company) and Visiting Professor in Economics at the Universities of Bath and Plymouth.
See: www.strategiceconomics.co.uk
In the last week, you have probably heard about the shutdown in parts of the US public sector following the failure of Congress to pass a budget. A number of people have asked me, “So, what does all this stuff in America mean for the Dorset economy.” My answer is “Don’t Panic”.
This story tries to summarise how it could affect us, now and in the future.
First, we need a simplified understanding of the complicated American budget process. Each year, the executive (President Obama’s government) sets out its budget plans and the legislature (Congress) debates and amends it and votes it through for the Presidency to finally sign into law. But, the Senate and/or the House of Representatives, particularly if they have a majority vote for the ‘other’ party (as the House does currently), often table their own proposals. Over the spring/early summer, the different options are argued about, within and between, the two parts of Congress, and negotiated with the Executive. Usually, a single united budget is set, voted through and signed off before they all go away for the summer… ahead of the end September deadline.
This year, following the split 2012 elections and the desire of the tea-party wing of the Republicans to reverse or delay “Obamacare” (perhaps, another Economics Story in its own right) resulted in a failure to agree by the deadline and, therefore, caused the current shutdown. Essentially, without a renewed mandate from Capitol Hill, the Executive had no authority to spend on about one third of its current activity from October 1st.
More importantly, America is also approaching its debt ceiling. Congress sets an absolute US$ amount of debt (government bonds) that the Executive/Treasury can issue to finance US government spending. Every few years, through the process of growth, inflation and political largesse, America comes up against this ceiling and a higher one has to be approved. Usually, this is a formality. This year, however, with the Republican majority in the House wanting to stifle the Democratic Presidency’s plans for health reform, it has not been. The next deadline is 17th October.
- Whatever the rights or wrongs of the politics, there are potentially significant economic ramifications for us all if these two matters are not resolved. The immediate effects of the shutdown are minor. It could shave a few percentage points off US GDP growth directly through the cut in government spending and indirectly through supply chains and lower consumption by the federal employees who are not being paid. But, assuming the furlough is brief (the last and longest was for 3 weeks nearly two decades ago under President Clinton), the slowdown will be made up before Christmas. If it were to persist for months, it would lower US growth this year. Trade and financial flows would be reduced and the dollar might slip, affecting Dorset exporters and investors. Right now, this seems unlikely. Don’t Panic … yet. Although some individuals are badly affected, shutdowns cause little or no damage to the economy. Indeed, by focusing public attention on the scale of government, they can have a positive side effect – restricting the rise in federal spending relative to GDP growth over the medium term.
- Although, again, it depends on how long it lasts, the effects of the debt ceiling barrier are more serious. Not being able to borrow would affect US spending much more significantly. It could hit confidence hard, affecting investment and hiring decisions, stock market valuations and the currency. Moreover, if there was an actual default – a failure to roll over existing US bond debts – the damage to global markets could be severe. The risk or reality of an American default would cause a shock wave of distrust that would overwhelm anything we have seen with Spain, Greece, Italy, Cyprus, Portugal or Ireland. Frightened of losing funds that they thought were safe in America, investors would sell other assets to recoup liquidity. In the rush for the exits, the banks would face a fresh and large credit crunch. Moreover, with policy makers already setting interest rates too low and fiscally strapped, the room for counter-action would be severely constrained. Dorset’s economy would not be safe from this tsunami. But, don’t panic … yet. I do not think this outcome is likely.
Maybe, I am too sanguine but I doubt US politicians are suicidal. The Treasury would run out of cash in about a month, forcing spending cuts worth an estimated 4% of GDP and starting another US recession. There is little doubt where the blame would fall. Also, for a while at least, the Federal Reserve can always print more dollars to pay off US$ loans. True, it would devalue the monetary base and the currency, leading to higher inflation and other economic problems down the line, but an actual default is unlikely.
What is happening between the two ends of Pennsylvania Avenue in Washington may seem a long way from Dorset business but, if they mess it up, 2008’s credit collapse will be written up as merely one stage of a deeper and longer malaise in the world economy. 2013 would become the new 1929 and Dorset’s economy, businesses and jobs, could not remain aloof from such a catastrophe.
But, surely, they are not that stupid. I expect this will all be settled in a few weeks and this ‘economics story’ will pass into myth and legend – at least, until the next time we approach the debt ceiling. Don’t panic … yet.
Professor Nigel Jump, 6th October 2013
