US Government Shutdown and US Debt Ceiling Explained – What Is the Impact on USD?

The US dollar has had a great month, as the Federal Reserve’s plan to gradually reverse its accommodative monetary policy starting with November has supported the greenback against majors. The American currency has managed to deal with the bearish pressure amid worries of a federal government shutdown. In the end, this scenario has been prevented by US President Joe Biden, but the debt ceiling issue still has to be addressed.

So what would a government shutdown have meant for the economy and people and what would the impact have been on the US dollar?

What Is Government Shutdown and How Does It Affect US Economy?

Every fiscal year, the US government has to be funded for the next twelve months or so, and if the two parties fail to reach an agreement on the budget until a certain deadline, part of government agencies are temporarily shutting down. The deadline this time was on September 30, and Democrats and Republicans were debating on government funding until the last minute. In the end, President Joe Biden signed a bill that prevented the shutdown that could have started as early as Friday, October 1.

While a government shutdown was avoided this time, it is not a rare occurrence, and even though the term sounds scary, it’s nothing of apocalyptic proportions, although there is nothing good about it. About three years ago, there was a government shutdown during the Trump administration that lasted for over 30 days, and it hasn’t impacted the US dollar that much in the long term.

Basically, in the scenario of a government shutdown, operations deemed to be essential continue, such as the postal service, air traffic control, in-hospital medical care (especially given the pandemic), law enforcement, and others. The areas that would have been affected refer to the agencies and programs that rely on annual appropriations, such as national parks, the National Science Foundation, Fish and Wildlife Service, US Geological Survey, Environmental Protection Agency, and the National Institute of Standards and Technology, among others.

But even the essential agencies would have worked at reduced levels. In the case of a shutdown, the Congressional Research Service estimated that over 2 million civilian federal employees would have been affected, as workers would have been either asked to work without pay or sent home.

Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget (CRFB), was cited by CBS News as saying:

Every shutdown is different — there is a lot of discretion in the agencies about what they can continue to do. Everything that’s not essential has to stop, but there are different definitions of essential work.”

Anyway, the good news is that with only a few hours left until the deadline, Biden signed legislation to avoid the shutdown scenario and keep the government funded through December 3, after Congress passed the bill earlier on Thursday, September 30, by green-lighting a temporary budget known as a continuing resolution.

Biden said in a statement:

There’s so much more to do. But the passage of this bill reminds us that bipartisan work is possible and it gives us time to pass longer-term funding to keep our government running and delivering for the American people.”

However, this is not the end of the story. There is an even bigger task that has to be tackled by the US government. Specifically, Congress has to raise the national debt ceiling limit before an estimated deadline of October 18. Currently, the debt is capped at $28.5 trillion.

What Is Debt Ceiling and What Happens if US Defaults?

Later this month, the US Treasury will run out of money to pay its obligations on bonds, and that means the government may face default if Congress doesn’t take measures. The good news is that the debt ceiling is artificially established by Congress, and it has been increased on several occasions in the past. The bad news is that no matter what happened in the past, there is a chance that the parties may not reach a consensus this time.

The problem is that this time everything is more complicated, as there is a third task that is directly correlated with the debt ceiling. It happens that Biden has to pass a $1 trillion bipartisan infrastructure bill and a $3.5 trillion partisan package that expands social services and addresses the climate crisis. It’s impossible to pass these bills without increasing the debt limit by a considerable amount. Republicans may choose not to raise the debt ceiling again in order to prevent aspects of these bills that they don’t agree with. While Republicans would definitely be ready to raise the debt limit, they are putting pressure on Democrats to suspend what they view as excessive spending plans, calling for a suspension in Biden’s multitrillion-dollar social policy and climate reconciliation bill.

Even without Biden’s massive packages, the Treasury is out of money, and failure to pay its bills would lead to the first US default in history. The House speaker, Nancy Pelosi, warned that the impact would be “cataclysmic” and cost 6 million jobs. Even when the US emerges from the crisis, it will permanently be a weaker nation, Pelosi said. On top of that, a default by Washington would send shockwaves through the global market, plunging the rest of the world into chaos.

Treasury Secretary Janet Yellen, who was Chairman of the Federal Reserve, said that the economy would fall into a recession if Congress doesn’t raise the debt ceiling until the deadline. She said on Tuesday, October 5:

It would be catastrophic to not pay the government’s bills, for us to be in a position where we lacked the resources to pay the government’s bills. […] I fully expect it would cause a recession as well.”

She went on to explain that US Treasury securities have been regarded as the safest asset on the planet, which partly accounts for the reserve status of the US dollar.

Placing that in question by failing to pay any of our bills that come due would really be a catastrophic outcome,” Yellen noted.

Earlier this week, President Joe Biden called on Congress to raise the debt limit as early as possible. On Tuesday, he said in a speech that he couldn’t guarantee that the debt ceiling would be lifted, blaming Republicans for not joining Democrats in their effort to address this pressing issue. The President said:

Not only are Republicans refusing to do their job, but they’re threatening to use their power to prevent us from doing our job — saving the economy from a catastrophic event. I think quite frankly it’s hypocritical, dangerous and disgraceful.”

On the other side, Republicans, led by Senate Minority Leader McConnell, argue that Democrats should handle the debt ceiling by using a budget process known as reconciliation, which would not require Republicans’ votes at all. However, Democrats oppose the idea, although they have to make a decision if they use the budget reconciliation as soon as possible. 

Needless to say, a default would simply smash the greenback, as it will end the dollar’s status as a world reserve currency.

“It’s complete craziness to even contemplate the idea of not paying our debt on time,” Moody’s Analytics’ chief economist Mark Zandi told CNN.

What’s Next for the US Dollar?

This is an important week for the American economy and the national currency, especially as the government will release the much-awaited Nonfarm Payrolls report, as we mentioned in our “week ahead” post.

So far, the US dollar has had a great period since the beginning of September, with the USD Index, which tracks the greenback against six other currencies, hitting the highest level in a year. However, the index is currently testing the support of an uptrend and seems to break below it.

Much depends on the Nonfarm Payrolls report and whether the two parties could prevent a default, so let’s stay optimistic. 

 

 

 

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Responses

  1. Very detailed, I appreciate that but i may have missed some key elements in it, would it be possible to get a summary of these posts just sp it is easier to understand ? Thank you!