The Government Shutdown and the Debt Ceiling: A Grave Prognosis

Congress, for the 18th time since 1976, failed to pass a budget for the fiscal year. For most of the population, things will go on as they have, but for 800,000 “non-essential” government employees, The United States seems to be at a standstill. Agencies including the National Park Service, NASA, the EPA, the NSF, the Chemical Safety and Hazard Investigation Board, and the Center for Disease Control have all closed their doors until further notice.

Photo courtesy of Skift.

(Here is an exhaustive list of all the agencies that have shut down.)

This latest lapse in government funding has come down to what seems to be the issue of the decade: the Affordable Care Act. The Democrats support it, but the Republicans won’t have it.  Since Republicans have the House Majority, and the House is responsible for all revenue bills, Republicans just might get their wish. Essentially, the GOP is claiming “the power of the purse” as it attempts to have the Affordable Care Act defunded in exchange for a new budget that will re-authorize the spending of federal agencies financed under the current appropriations legislation.

According to the International Monetary Fund, however, our healthcare debacle, along with the government shutdown, is the least of our problems. If Congress doesn’t reach some agreement by October 17th, when the U.S. exhausts its borrowing capacity, then the US could possibly default on its debt and cause another global economic crisis.

Let’s backtrack: there are a few ways a government can finance its programs. It can levy taxes, print money or issue treasury bonds. Since higher taxes and the higher inflation that comes with printing money aren’t popular with voters, congress has favored the issuance of bonds in for funding legislation.

Treasury bonds are debt. We sell the bonds and then pay back the price of the bonds, with interest of course, in increments ranging from one to 30 years (depending on the maturity of the bond). What makes Treasury bills so attractive is that they are considered to be the safest assets on the planet; compared to other countries, the U.S. rarely shirks its debts. After the debt ceiling has been reached, the U.S. will no longer be able to sell treasury bonds to cover its debts and its credit will have been overextended to the point where creditors can no longer be paid. In other words, the U.S. will have been cut off from its ability to borrow to pay off its loans and we will default as a nation.

Now, while some might find it a relief that the U.S. is forced into some budgeted austerity, the International Monetary Fund sees grave consequences in Congress’s inaction. Current projections see foreign creditors, confronted with the questionable safety of their assets, choosing to invest elsewhere. This has immense repercussions. Since treasury bills can only be paid for in U.S. dollars, 66 percent of all foreign reserve currencies are in dollars (about half a trillion). To reinvest in other nations, creditors will be forced to sell their dollars, i.e. put them back into circulation. The dollar would devalue, prices could potentially skyrocket and the economic effects could buffet throughout the world economy. Growing economies, such as China, India, Brazil and Russia, will see their growth stagnate as the dependable, low interest loans they need are cut off with the discontinued sale of treasury bonds. With more dollars in circulation, domestic retirement funds could see a substantial loss in value as American’s nest egg cracks and crumbles under the weight of inflation.

NOTE: This article was written prior to Wednesday evening, when Congress approved a proposal to fund the government through Jan. 15 and extend the debt limit through Feb. 7. President Obama signed the bill at around 12:30 a.m. on Thursday.

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