Everyone I talk to, including every client and advisor, expects fallout in various ways.
The most obvious would be a reduction or suspension in non-essential services such as parks, monuments and so forth. This will reduce traffic in certain areas of the country, with the attendant reduction in business.
Of slightly greater concern is the reduction in administrative services for licenses, visas, passports and the like, which will slow down international commerce as well those who depend on federal licensure to do business (pilots and Enrolled Agents come to mind, as I am both of those). The IRS is essentially shutting down regular random audits. This might cause a rise in fraudulent tax return filing or filing returns taking an aggressive tax position. The FAA will close selected towers, and furlough/reduce ATC controller staffing, which will slow down airline travel.
'NOT MUCH IMPACT'
All in all, a government shutdown would be a major irritant, but would not have much impact on our clients or commerce in general. History supports this position. Since 1976, the year before I left the Navy and went back to grad school, there have been 17 shutdowns lasting a total of 110 days. Of those, only six occurred during recessions, so the majority happened while the economy continued to grow.
The one that gets the most comparisons was the three-week shutdown during the Clinton administration in December 1995 to January 1996. GDP grew at an annual clip of 2.3% in 1995, 2.9% in the fourth quarter of 1995, and 2.6% in the first quarter of 1996, according to the U.S. Department of Commerce. Washington was also rocked by a major blizzard (about 10 inches of snow fell where I lived) which exacerbated the shutdown. So, not much impact at all, or as I said back then, were living on so much government pork, we wont burn the excess off for months, if not years!
Where there could be an impact is on many defense and other agency contractors who have 100% of their income from the federal government. Almost every federal agency, department and branch uses outside consulting, installation, service, logistics and maintenance support for much of what they must do day-to-day to either stay in operation or provide services. Much of this will go into suspense if the government shuts down.
The short-term financial ripple in the greater Washington metro area could be substantial. One client said to me today: Im not meeting with my government contractor clients tomorrow. If a shutdown extended for months rather than days or weeks, it might create a mini-recession in areas where the federal government has a large presence, such as a military base or large federal installation domestically or overseas. Washington is certainly such a place.
Of much greater concern is the potential for a government default should the debt ceiling not be raised. Our clients are much more concerned about this possible event. Anyone who has followed federal economics knows the government spends approximately $1.00 for every 60 cents in revenues. Not speaking politically, but just doing simple math tells us that federal debt will increase given this income/outflow trajectory, no matter what any politician says.
Much has been written on the ability of the U.S. to increase debt to such-and-such a level at such-and-such a speed, and many economists have conjectured as to the short-term and long-term consequences of doing so. Some see the eventual fall of the U.S. dollar as the default world currency, with the attendant problems that might bring for certain sectors of the U.S. economy, the standard of living for many who depend on imports personally or professionally, and the power of the U.S. in foreign relations. Others see the expansion of debt as necessary for sustaining growth. The speed of expansion is what most economists argue about, and is the major concern of the Federal Reserve Board.
ACCLERATE WEAKNESS OF THE DOLLAR
Having said all that, a federal government default would surely accelerate the weakness of the U.S. dollar, and may have other repercussions which have been debated at great length by economists, business people, investors and ordinary citizens like me. No one knows for sure what would happens, as the US government has not had a default since the creation of a central bank and US currency. If there was a government shutdown, with all of the visible cessation of support and administrative services for a short period of time, followed in short order by a federal default, there is a distinct possibility of great volatility in the equity and bond markets.
Remember when the buck was broken during the global financial crisis, when a large money market fund defaulted and the value of its share was driven below $1.00 per share? This was only one indicator of larger, deeper systemic issues with the financial system, based in part on assumptions of stability and safety (always upward trending) in housing prices. You know the eventual result. If the U.S. defaults on its obligations like other nation states have in the past, the economic consequences to investors and businesses could be substantial, depending on the domino effect on creditors and investors.
MAINTAINING DIVERSIFIED PORTFOLIOS
What we are doing as a firm is to maintain broadly diversified portfolios for clients, with substantial components of foreign investments. The U.S. GDP is currently less than 50% or world GDP. The revenue component of Savant portfolios from domestic equity and fixed-income investments is less than 50% of total business revenues from all global equities and fixed-income investments. We are talking and writing more about the domestic and political issues which could and will affect our clients and letting them know we are carefully watching the developments in Washington and financial markets around the world.
NOT RUNNING FOR THE HILLS
What we are not doing is running for the hills. Having just emerged from the second-worst financial recession since the great depression, we have learned some new lessons and confirmed some past lessons about portfolio management and investor behavior.
The markets will have short-term emotional reactions to whatever happens. The long-term performance will be based, as it always has been, on the underlying profitability and growth of the companies whose stock and bonds we buy. In the face of what can best be described as government dysfunction on a wide scale around the world, businesses will continue to succeed and grow.
Glenn G. Kautt, CFP, EA, AIFA, is a Financial Planning columnist and vice chairman of Savant Capital Management, based in Rockford, Ill.
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