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05 Sep 2013

US showdown over shutdown

Kevin Logan

by Kevin Logan

Chief US Economist, HSBC

US showdown over shutdown

In January the Treasury reached its debt limit and had to resort to “extraordinary” measures to fund obligations

The US Congress has three fiscal disputes to deal with after the summer recess. A 2014 budget must be adopted, the Treasury’s debt limit has to be increased, and the question of whether to replace or continue budget cuts required by the Budget Control Act of 2011 must also be resolved.

Not adopting a budget before the start of the fiscal year could lead to a shutdown of government services and disrupt economic activity – something both Democratic and Republican leaders say they want to avoid. Allowing the across-the-board budget cuts required by sequestration legislation to continue would intensify the drag on economic growth.

Failure to raise the Treasury’s debt limit would eventually cause the government to default on some of its financial obligations – a development that could cause chaos in financial markets worldwide.

The fight over budget priorities in 2011 involved holding up legislation to increase the Treasury’s debt limit and led to a near default, with Standard & Poor’s downgrading the country’s AAA credit rating. But although leaders of both parties say they want to avoid that scenario this year, neither side has shown much willingness to compromise.

The Republicans will likely give some ground on current spending cuts in exchange for long-term spending reductions in entitlement programmes, but they want no new revenue as part of a deal. Democrats will accept some reform of the entitlement programmes, but only if new revenues are included.

Not adopting a budget before the start of the fiscal year could lead to a shutdown of government services

With no time to forge a budget compromise before the new fiscal year starts in October, a temporary “continuing resolution” will probably provide funding for discretionary programmes for a few months, giving legislators time to seek a deal acceptable to both sides. The initial resolution could be for a few weeks or a few months, depending on the tactical positions the negotiators take.

A crucial issue for the passage of a continuing resolution is whether or not it contains changes to funding for the Affordable Care Act (ACA) – often dubbed “Obamacare”. Conservative members of the House Republican caucus are demanding that a resolution includes a provision to “defund” the ACA. If the Senate refuses, the House conservatives feel they can blame the Democrats for any government shutdown that follows.

In January 2013 the Treasury reached its legislated debt limit and had to resort to “extraordinary” measures to keep funding its obligations. In February, Congress temporarily suspended the debt ceiling until mid-May when it was reinstated at the level of debt then outstanding.

When the debt limit took hold in mid-May the Treasury again implemented its extraordinary measures. In late August the Treasury Secretary indicated that beyond mid-October, it could operate only with its cash on hand, forecasted to be about USD50 billion.

That cash would probably be used up by early November, if not sooner. On the first day of each month the Treasury makes about USD17 billion in Medicare payments and pays USD25 billion to retired Civil Service and active military personnel. On the third day of each month about USD25 billion goes out to Social Security beneficiaries.

The Treasury would have to delay payments for government activities and possibly default on its debt obligations. The prospect of a breakdown in financial markets and in paying retirees, healthcare providers and civil servants should motivate Congress to increase the debt ceiling. However, the Speaker of the House has indicated he is prepared to use the ceiling as leverage to force changes that the normal political process will not ordinarily produce.

This research was first published on 2 September 2013.