The following article from Magellan Asset Management is a great explanation of the US Government Shutdown and what the likely implications are.

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The shut down and debt ceiling issues may generate short term noise and market volatility, but ultimately both will be resolved with minimal long term impact on the economy.

Why is there a shutdown

·         The previous financial year ended on September 30.

·         Congress has been unable to pass a budget bill allowing it to pay non-essential workers for FY 2013/14

Impact of the shutdown

·         ~800,000 workers are now on unpaid leave.

·         Essential services are still operating. Eg Medicare, social security payments.

·         The shut-down is not expected to materially affect US GDP growth unless its runs for a number of weeks. There are estimates the shutdown will cost the US 0.1-0.15% of GDP per week in lost output.

·         Nonetheless, it may affect market and ratings agency confidence in the US government if it continues for an extended period.

·         Market sentiment negativity will likely increase if the shutdown continues towards 17 October, the deadline for lifting the $16.7tr debt ceiling. Markets are likely to be far more focused on debt ceiling negotiations than the shutdown.

The politics and timing of the shutdown

·         This is the first shutdown since 1996. The US has partially shut down on 17 prior occasions, normally not for longer than a few days. The longest shutdown was also the most recent – 21 days from 16/12/1995 to 5/1/1996

·         The Republicans, particularly the Tea Party faction, are seeking to link approval for the budget bill with a delay in the implementation of “Obamacare” for a year. The Democrat-controlled Senate  and President have refused to make this linkage.

·         The 1996 shutdown was driven by Newt Gingrich, the Republican House Leader at the time. Voters viewed that shutdown negatively, with a backlash against the Republicans, favouring Clinton’s 2nd re-election.

·         The more sensible elements of the Republican Party recognise the negative backlash on them from an extended shutdown, which will likely spur inter-Republican debate to limit the duration of the shutdown.

The debt ceiling

·         The US Treasury is currently using ‘emergency measures’ to keep the US government debt below its $16.7tr ceiling. These emergency measures are expected to be exhausted by October 17.

·         Without action from Congress to raise the debt ceiling, Treasury would be unable to issue new debt and have only $30 billion in cash plus incoming taxes and fees to meet its obligations. The Congressional Budget Office forecasts that this amount of money would be exhausted between Oct 22 and Oct 31, causing the US to default on its obligations.

·         It is very unlikely that Congress will not raise the debt ceiling, as the US failing to meet its obligations would have potentially massive consequences for financial markets and the economy (unlike the shutdown).

·         The debt ceiling may be used by Congress in the short term as a political negotiating tool. There have been 53 previous increases in the US debt ceiling, of which 26 were “clean” i.e. with no strings attached legislation. The remainder were part of a package of negotiated bills. It is possible that Congress could wait until the last possible moment. Eg the 1989 debt ceiling increase.

·         In the very unlikely event that Congress fails to raise the debt ceiling in time, there are last resorts available for the US to avoid default. Eg the President has the power under the 14th Constitutional Amendment to issue debt and prevent a default.