Danger to economy worries experts weighing potential government shutdown, default

A prolonged government shutdown — followed by a potential default on the federal debt — would have economic ripple effects far beyond Washington, upending financial markets, sending the unemployment rate higher and slowing already tepid growth, according to a wide range of economists.

A shutdown of a few days might do little damage, but economists, lawmakers and analysts are increasingly bracing for a shutdown that could last a week or more, given the distance between Republicans and Democrats. Such an outcome would suck money out of the economy and spread anxiety among consumers and businesses in a way that is likely to hold back economic activity.

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Countdown to the (possible) shutdown
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Countdown to the (possible) shutdown

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And a default on the federal debt, which may occur within 30 days without congressional action, would be much worse, economists say. Failing to raise the debt ceiling would require the government, a major driver of growth, to cut spending by about a third, potentially forcing delays in Social Security checks, military pay and payments to doctors.

There are other risks, too. On Oct. 17, the Treasury is scheduled to ask investors for $120 billion in loans. But if investors grow nervous about whether the United States will be able to pay them back, they are likely to demand higher interest rates, which would cause rates to spike throughout the financial system, leading to more expensive mortgages, auto loans and credit card bills.

Doubt could grow about the safety of parking money in U.S. bonds, the linchpin of the global financial system.

“It’s corrosive on the economy,” said Mark Zandi, chief economist of Moody’s Analytics. A lengthy shutdown followed by a default would be “the nightmare of the recession all over again.”

Even if lawmakers find a way out of a shutdown or a default, this fall’s brinkmanship — the fourth such crisis in two years — is likely to have negative effects on the economy. With so much uncertainty in Washington, economists say that businesses, flush with cash, have been reluctant to invest and hire.

“The simple story is it creates a tremendous amount of uncertainty,” said Ethan Harris, a top economist with Bank of America. “One of the unfortunate side effects of the brinksmanship is a message to business leaders to delay long-term commitments and wait to see whether something really bad happens.”

There are already signs of intensifying anxiety in the financial markets, which had largely brushed off the fiscal clash previously.

The stock market, as measured by the Standard & Poor’s 500-stock index, was down four of five days last week, and the dollar also fell. More relevant, the cost of a type of insurance that investors use to protect themselves against default in U.S. government bonds has rocketed higher in recent days, suggesting the chances of default are increasing.

Business interest groups, usually aligned with the Republicans, have urged the GOP to abandon their demand for policy concessions, such as delaying President Obama’s signature health-care law, in exchange for funding the government and raising the debt limit.

“It is not in the best interest of the employers, employees or the American people to risk a government shutdown that will be economically disruptive and create even more uncertainties for the U.S. economy,” the nation’s leading corporate lobbying groups, led by the U.S. Chamber of Commerce, wrote Friday in a letter to Congress.

Much of the government will close Tuesday without action by Congress. If the shutdown lasts more than a few days, it would affect the economy in numerous ways, most clearly by cutting spending on contracts and salaries.

But there are likely to be a wide range of indirect effects as well, because government operations provide the launching point for key activities driving economic growth, according to independent economists.

For example, the closure of national parks and museums may hurt hotels, restaurants and the people who work for them. The process of getting approval for a home loan could take much more time, slowing a housing recovery that is one of the few bright spots in the economy.

Headlines about dysfunction in Washington could also sow consumer and business fears even in parts of the economy not directly affected by a shutdown, leading individuals and businesses to cut back on spending and investment.

Economists estimate that the cumulative effect of a prolonged shutdown could trim economic growth in the final three months of the year by up to 1.4 percentage points. Under that scenario, the economy would hardly expand at all — at a time that is usually one of the most important economic periods of the year.

“That would mean a hit to employment and income as we approach the critical holiday season,” economist Diane Swonk of Mesirow Financial wrote in a recent analysis.

But for all the worry about a shutdown, economists are far more concerned about a potential default on the federal debt. The Treasury Department has warned that it will have only about $30 billion in cash on hand by the middle of next month, and estimates are that it will run out of money by the end of the month.

If it is low on cash, the government is likely to hold back on payments until enough money comes in by way of tax revenue, according to a Treasury Department inspector general’s report.

Social Security checks, veterans’ benefits and active-duty military pay could be delayed two weeks, according to estimates. Such delays would not only disrupt lives but also cause an economic contraction because that money often flows directly into the economy through grocery shopping, car sales and staple purchases.

Until recent weeks, many economists and investors have seen the prospect of a debt default as unthinkable because so many people around the world rely on the safety of U.S. Treasury bonds. But people close to the process now say it is all too possible.

“This Congress is dysfunctional, and I can no longer predict what it’s going to do,” said Rep. James P. Moran (D-Va.). “I can’t tell you for sure we’ll avoid a debt default. That’s mind-blowing.”

Steve Bell, a former senior Republican budget staffer and a top analyst with the Bipartisan Policy Center, said the issues surrounding the congressional battles this fall leave little room for error.

“What is different this time . . . is going to be the direct conflation of the debt ceiling and continuing resolution for appropriations,” he said. “That’s when the stakes are highest.”

 
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