What is happening in the US?
The US Congress has not passed the necessary legislation to authorise spending for Government programs by the due date September 30th. The US Senate has passed the legislation to authorise spending for the next 12 months but the House of Representatives (Republican Party controlled) has rejected the Bill as they do not support President Obama’s new healthcare bill and this is their way of politically forcing the Presidents hand and dilute the new Healthcare Bill. The dispute is also about the Parties disagreeing over the need to raise the US Governments borrowing limit, the “debt ceiling” which must be raised by October 17 or the Government could go into default on its current debt.
What is the first consequence?
The Government has been forced to shut down certain non-essential services, in effect sending 800,000 public servants home. This is not the first time, in December 1995 a similar shutdown occurred and there have been 17 shutdowns between 1970 and 1980. The current shutdown is estimated to cost the US economy .1% of GDP per week. A return to work and the payment of back pay will eventually reduce this impact but it needs to be resolved.
What is likely to happen?
Both US political Parties are aware of the long term ramifications of a debt default particularly as the message this would send to the rest of the world would be that the US cannot manage its own fiscal affairs. Therefore there is likely to be a solution but not before each political party extracts some concessions in tax reform and the Healthcare Bill. It is most likely that there will be a short term solution reached before the 17th October to ward off a disaster and to give both parties time to seek more permanent resolutions.
What does it mean for the local Investor?
Generally the most disappointing aspect of this whole issue is that beforehand the US economy seemed to be showing signs of recovery and providing confidence for the rest of the world. The US economy still seems to be seen as the bellwether for the other economies and investors worldwide. If the US are seen as poor managers of their own budget and are allowing political games to cause such disruption this confidence may dissipate..
In real terms there will be market volatility until a solution to the US problem is found however this volatility may only be temporary as equity valuations are reasonable and growth in the Australian economy has been showing positive signs.