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By HaleStewart October 16, 2013 10:22 am
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The Already Negative Impact Of The US' Political Brinksmanship

The US is currently engaged in an extreme case of brinksmanship with it's credit rating hanging in the balance.  However, outside of the political calculations currently taking place there are two key areas of the economy which these events are already negatively impacting. 

The first of these is the "repo" market. It's essentially a short-term collateralized loan market where one party will give a second party a specific amount of treasury bills in exchange for a short-term loan (usually under 30 days).  For example, Company A needs $10 million because of an unexpected cash short-fall -- which is actually a fairly common experience.  But while Company A may be short on cash, they do have Treasury Bills as part of their overall short-term cash management strategy.  They give $10 million of T-Bills to a second party who essentially makes a collateralized $10 million dollar loan to the first party.  30 days later, Company A has sufficient cash on hand to repay the loan, so they  get their $10 million in T-Bills back; the lender makes a few basis points in interest income.

Here's the rub: this transaction -- which is incredibly common and a bedrock of modern treasury management -- requires a "riskless" security to perform.  Enter the T-Bill which is backed by the full faith and credit of the US government.    In the example above, Company A says, "I've got $10 million in T-Bills" and Company B says, "great."  The paperwork is minimal (it may be originally documented only in e-mails) and a few wiring transactions later company A has cash on hand.  But remove the riskless nature of the T-Bill and you've got big problems in the financial world as this market grinds to a halt, making short-term lending impossible.  That completely cripples trade and commerce, and that is why this situation is so deadly.

The second problem is that federal spending has accounted for about 20%-24% of total US GDP for the last 30 years.  In fact, government spending is a key component of the GDP equation which is expressed as GDP = C+I+G+X, where C=consumer spending, I=investment, G=government spending and X is net exports.    And according to the latest IMF findings, government spending actually has a larger impact during slow economic periods:

This paper investigates the relation between growth forecast errors and planned fiscal consolidation during the crisis. We find that, in advanced economies, stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis. A natural interpretation is that fiscal multipliers were substantially higher than implicitly assumed by forecasters. The weaker relation in more recent years may reflect in part learning by forecasters and in part smaller multipliers than in the early years of the crisis.

And for the last three quarters, federal spending -- or more specifically the lack thereof -- has subtracted from overall US growth as shown in this chart:

As we see, for the last three quarters, the sequester has been a net drag on growth.  Economist Jeff Frankel noted the following regarding this data:

GDP growth has fallen well below 2% in the last three quarters.   But I think we know the reason for that:  dysfunctional fiscal policy.  Washington has been the obstacle to a normal robust recovery, through a combination of such factors as spending cuts since 2011, the expiration of the payroll tax holiday in January 2013, the sequester in March, and now business uncertainty arising from new time-bombs in the next two months, once again the needless result of partisan deadlock over passing a budget and raising the debt ceiling.  Given all that, it is surprising that private consumption and investment have held up as well as they have.

And we are already seeing the negative effect of these political developments in the weekly economic numbers:

The effects of the US government shutdown, and the potential for actual default, are beginning to show up in the weekly numbers. Most importantly, consumer spending has nearly stalled as measured by Gallup, and has slowed significantly as measured by the ICSC. Consumer expectations cratered. Tax withholding since October 1 is miserable. The TED spread crashed lower.

UPDATE: We're also seeing a negative impact on housing and auto sales -- two areas of the economy that had been bright spots in the expansion.

Regardless of your political philosophy, it's impossible to ignore the basic fact that recent political events are already slowing an already weak US economy.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer


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