Risk Spotlight: The United States

By Christopher McKee, PRS Group

Ending the crisis: what might it take?

It appears that ending the budget impasse in the US will require a concession on the part of the Democrats that enables the Republicans to save face while retreating. The Democratic position is that they will not negotiate under crisis conditions. Obama and Reid insist that they will make no concessions “with a gun to our heads,” and under no circumstances will they agree to any changes to a continuing resolution that threatens the implementation of the ACA, which is the signature policy achievement of Obama’s presidency.

The ACA has been a target of the Republicans from the moment it was signed into law in March 2010. The first bills to repeal “Obamacare” (an initially disparaging nickname that has now come into general use) were introduced in the House one day after Obama signed the law, and the lower congressional chamber has held no less than 40 separate repeal votes since, all of them purely symbolic, as there was never a chance that the Democrat-controlled Senate might do likewise.

The first step on the path to a shutdown was House approval of a continuing resolution that stripped the spending plan of funding for implementation of Obamacare, which the Senate promptly amended to restore the funding. The House subsequently approved an amended continuing resolution that included provisions delaying enforcement of the ACA’s individual mandate for one year and removing a tax on medical devices.

As Democrats see it, both the individual mandate and the tax on medical devices are essential to the financial soundness of the program, meaning that the House bill would still have left the ACA underfunded, increasing the likelihood of its failure. On that basis, the Democratic majority in the Senate approved a bill that removed the House’s amendments.

With time running out, Boehner called on Reid to enter into negotiations to reconcile the differences in the House and Senate versions. Reid responded that he would only discuss the Republicans’ amendments after the House had approved a clean continuing resolution that ensured at least a temporary extension of funding for all government operations. Lacking the necessary support of his own party to agree to Reid’s terms, Boehner rejected the Senate leader’s offer, and the clock ticked down to zero.

The Republicans have done their level best to pin the blame for the shutdown on Obama and the Democrats. Although polls show that voters are unhappy with both sides, the Republicans are consistently viewed as the main culprit, and polls of voter intentions at the 2014 mid-term congressional elections, while hardly a reliable gauge at this point, nevertheless indicate that a prolonged shutdown could end up costing the Republicans control of the House of Representatives.

Such considerations are clearly weighing on the minds of many within the Republican caucus, some of whom have publicly criticised the party’s strategy as political suicide, and called on Boehner and the Tea Party to admit defeat and move on. Even so, Boehner remains unwilling to walk away empty-handed.

One path out of the crisis may be an offer by the Democrats to approve repeal of the tax on medical devices, which is very unpopular, and could be sacrificed without gutting the entire Obamacare program. By making such an offer, the Democrats would be better able to fend off the Republicans’ charges that they are unwilling to compromise, leaving the Republicans even more vulnerable to shouldering the blame for the shutdown if they refuse the offer. The move would be a low-risk gambit with potentially high returns for the Democrats in terms of the politics, but there is as yet no indication from the Democrats that they are prepared to offer even that much.

Credibility eroding

The costs of the shutdown are not merely economic ones. The impasse has also undermined the international stature of the US, as foreign leaders wonder out loud whether officials in Washington are capable of getting their act together before their dysfunctional relationship triggers damaging reverberations across the globe. IMF Managing Director Christine Lagarde spoke for many when she declared that the world “is bemused, but not amused” by the game of political brinkmanship being played by Obama and the Congress. It is a safe bet that such sentiments will be echoed many times over at an upcoming meeting of European finance ministers.

Plummeting confidence in the reliability of the US to avoid risky manoeuvres that threaten the stability of global markets is hardly a trivial development. US influence on market behavior across the globe has been painfully evident in recent months, as indications that the US Federal Reserve is readying to ratchet back its quantitative-easing program has contributed to significant currency volatility in several major emerging markets.

With the federal shutdown and the threat of default adding to the uncertainty surrounding the timing of a move by the Fed, the governments in affected countries find themselves at a loss about how to prepare for the inevitable shift in US monetary policy. The frustration is becoming palpable, and resentment is building.

Political disruptions reinforce economic slowdown

In terms of US economic performance, the timing of the crisis is most inopportune. The sluggish recovery sputtered in the third quarter of the year, when annual real growth is estimated to have slowed to about 1.5%, after accelerating to a still-disappointing 2.5% in the second quarter. Over the first nine months of 2013, real GDP growth has averaged just 1.7%, compared to last year’s annual growth rate of 2.2%, and with the shutdown certain to have a negative impact on fourth-quarter performance, the annual rate is forecast to slump to just 1.4%, at best, with obvious significant downside risks apparent.

Growth has been hampered throughout 2013 by the aforementioned state spending cuts mandated under the deal that ended the stalemate over the debt ceiling in 2011. The unimpressive preliminary estimates for the third quarter are attributable to a deceleration of export growth (which was a key contributor to the stronger second-quarter performance) and weaker household spending that hit sales of consumer durables, as well as a slowdown in sales of new homes. A protracted political crisis will inevitably reinforce the domestic weaknesses, and conditions of heightened anxiety over the prospects for the global economy pose a significant obstacle to improving on US export performance in the coming months.

In late September, Fed Chairman Ben Bernanke indicated that a reduction in its $85 billion-per-month bond purchases under the quantitative easing program could be initiated as early as December 2013, based on the outlook for the economy at the time. The outlook has already worsened, but whether by enough to alter Bernanke’s plans is uncertain at this point. For its part, the IMF has concurred that it is time to begin winding down the quantitative-easing program, but has called upon the Fed to move very gradually so as to minimise the volatility of capital flows.

Inflation data reveals little sign of building price pressures that might necessitate a rapid tightening of monetary policy. The headline inflation rate eased to 1.5% (year-on-year) in August, after coming in slightly below 2% in both June and July, and the consumer price index rose by just 0.1% compared to July, below the anticipated rate of 0.2%. The lower August inflation figure was largely attributable to 0.1% (year-on-year) fall in energy prices, as a 2.2% decrease in gasoline prices offset a 4.8% rise in the cost of piped gas.

Significantly, the Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) index, fell by 0.1% (quarter-on-quarter) in the April–June 2013 period. The negative figure—the first since the depths of the recession in early 2009—is an indication of generalised weakness of demand. On that basis, increases in the consumer price index are forecast to come in below 1.5% in the coming months, resulting in average inflation for the year of just 1.4%.

The current account deficit totaled slightly more than $200 billion over the first half of 2013. The narrowing trend will persist over the second half of the year, despite slower growth of exports, as weaker domestic demand and the moderation of global food and fuel prices dampens the growth of imports. The current account balance is forecast to narrow to 2.3% of GDP this year, and an even smaller shortfall is possible in the event of a protracted government shutdown that contributes to slower-than-forecast real GDP growth and weaker aggregate demand. 

By Christopher McKee

Christopher McKee, PhD, is CEO and Owner of the PRS Group Inc, a US-based, quant-driven, country and political risk rating and forecasting firm in operation since 1979. A former academic and current private equity investor, Chris is the author of several publications dealing with international business and risk, and has lived and worked in a range of emerging markets, including Latin America, South East Asia and North Africa.

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