The United States Shutdown: What are the key economic effects?

We’ve arrived at that time of year when the debate over the budget in the United States typically takes place. If not approved, the country goes into shutdown, which obviously interferes with its entire internal organization, while attracting global attention. After all, the country does have the largest economy on the planet.

In international financial markets, the situation deserves to be highlighted, as there’s always the risk of increasing asset volatility. We invited Victor Arduin, Market Intelligence Analyst at hEDGEpoint, to better explain:

• What the shutdown is, and what the current state of negotiations is
• What the main shutdowns in history have been
• What its potential effects are
• The key role of hedging in this scenario.

Keep reading to learn more!

What exactly is the shutdown, and what’s the actual state of negotiations?

The shutdown in the U.S. is the period in which the North American government discusses its budget for the following fiscal year. If consensus isn’t reached, this means that several government services will necessarily be stopped.

The U.S. needs to carry out its budget allotment annually. According to national law, approval must occur by the first day of October, Arduin explains.

“When Congress cannot reach an agreement, public sector entities can’t spend money. This creates a scenario where essential services are paralyzed,” he continues.

The budget’s form is essential as it determines the country’s priorities, such as spending on defense, health, education, and others. In addition, it includes discretionary expenses which are those that may or may not be carried out, according to the revenue forecast. They’re divided into 12 agendas that must be approved by both the Congress and the Senate, related to issues such as agriculture, trade, and energy.

The stoppage can be total, if none of these 12 bills is approved, or partial. If an agreement can’t be reached, the government usually resorts to stopgap measures, a temporary situation that postpones the budget’s definition. This is the dilemma we find in the U.S. right now.

“This year, there was an agreement to postpone the shutdown. In other words, Congress used legal instruments to guarantee the country’s operation for at least another 45 days,” Arduin pointed out.

What have been the biggest shutdowns in U.S. history?

The last three largest shutdowns in the U.S. happened during the Bill Clinton, Barack Obama, and Donald Trump administrations.

“The average shutdown lasts eight days. But in those governments, the extension was more substantial,” Arduin recalled.

In 1995, under the Bill Clinton administration, activities were suspended for 21 days all told. Disagreements over budget cuts between the Democrats and House Speaker Newt Gingrich resulted in that shutdown.

Back in 2013, the impasse arose due to the “Patient Protection and Affordable Care Act” (PPACA). Sanctioned in 2010, and popularly known as ObamaCare, it aimed to expand health insurance coverage, thus democratizing the population’s access.

The Republican-controlled House of Representatives was determined to dismantle or delay the law’s implementation by arguing against tax increases. The Democratic-controlled Senate opposed those efforts and simply didn’t accept funds being withdrawn from the program. What was the result? A shutdown for 16 days due to this lack of agreement in Congress.

However, it was as recently as 2018 that the government entered the longest shutdown in history, lasting all of 35 days. The impasse occurred because Donald Trump, president at the time, would only approve the budget if another US$5.7 million was included. The objective was to allocate this money to fortify the border wall between the U.S. and Mexico. But the Democrats opposed the request.

As a result, several government agencies were partly closed while approximately 800,000 federal employees were impacted, having to work without pay. Government services operated with limited capacity or were interrupted. All in all, it’s estimated that the shutdown deprived public coffers of US$11 million.

The Shutdown: Find out the local and global economic effects

Although the shutdown tends to have more local effects, there’s always the risk of it developing into a larger crisis impacting global financial markets. In 2018, for instance, the stock exchange performed unfavorably due to the shutdown, adversely affecting company stocks worldwide.

“The negative effects tend to be more specific and limited to the United States. The shutdown has never become such a big problem that it’s impacted the entire world,” elaborated Arduin.

He also highlighted that there’s no substantial connection that affects the demand for commodities. What’s observed is that the risk of a shutdown is increasing in the U.S. In practice, this translates into higher interest rates, which can have consequences for future commodity prices.

“In the short term, there’s a reduction in consumption by a considerable portion of the population due to the interruption of specific services and delays in wages. There’s also a decrease in the acquisition of goods and services by government agencies. In the medium and long terms, there’s a greater fiscal risk, translating into higher interest rates,” Arduin continued

To better understand the scenario of rising interest rates in the United States and its impacts, please read our exclusive content.

The economic contraction is temporary and must be recovered through budget normalization. However, if the shutdown carries on, it can hit the private sector more severely.

“The market prepares itself by envisioning what could happen but assumes there’ll be a solution within these 45 days. If the basis of opposition to the current government is very strong, risky asset markets could face volatility, like the situation in 2018,” Victor Arduin affirmed.

hEDGEpoint: Full analysis of all factors that can affect commodities

Closely monitoring all movements that have the chance to affect commodity markets is vital for anyone working in this sector. At hEDGEpoint, we’re always aware of the events that lead to such potential changes.

With this in mind, we offer suitable hedging instruments to help you make more assertive decisions. We work with a team that truly understands all the aspects that generate volatility in commodity markets. We provide hedging products capable of giving greater protection to players at all stages of the chain while combining market intelligence with detailed data analysis.

Talk to a hEDGEpoint professional today to find out more.