U.S. Govt Shutdown Not Debt Crunch… But Mess Can Spread Fast

The distinction has been drawn by the former Chief Economist of the Federal Reserve, David Stockton, who is now at the Peterson Institute for International Economics (the think tank which was virtually ‘bought’ in 2005 by Blackstone’s co-founder and Treasury Secretary under President Richard Nixon, Peter Peterson).

Stockton has produced some guesstimates on the cost of the government shutdown. According to his calculations, it has already cost 0.15 percent of GDP (at and annualized rate) and, if it continues, its toll next week will be the same. The third and the fourth weeks it will grow to 0.2 percent each. And nobody in his right mind envisions a longer than five weeks government shutdown, but it is nonetheless truth that the Tea Party does not have the same mental architecture of the rest of the world.

Even a loss of 0.7 percent of GDP would be easily absorbed by the US economy. First, we must reckon that those numbers are ‘annualized’. That means that they are the result of deducting the fourth quarter real GDP from the third quarter real GDP, raise the number to the fourth power, deduct 1, multiply by 100, and then round the result. In short–this implies that 0.7 percent annualized growth, albeit significant, it is far smaller that 0.7 percent year-on-year or quarter-on-quarter.

The impact of a potential debt default is impossible to fathom. In 2011, when the Republican Party almost manufactured for political reasons a debt crisis, the market remained oblivious until the very last few days, and then, after the crisis was averted, reacted with brutal volatility. There were days when 90 percent of the stocks listed in the S&P500 ‘flipped’ over at least once, losing all their intra-day gains (or recovering all their losses).

The good news is that the Republican leadership seems not so eager to bend its knee in front of the Tea Party this time. The speaker of the House, John Boehner, has stated privately that he will not allow the United States to default, no matter if that means breaking the Republican Party in two (and therefore, ending his leadership). This news seems to confirm Warren Buffett’s assessment on the debt ceiling crisis: “We will go right up to the point of extreme idiocy, but we won’t cross it”.

The bad news is that, as a bargain chip with his own Republican fellows, Boehner will have to keep the government shutdown for longer. So, in the end, the outcome could be instability because of the debt, and a prolonged government closure.