How Each New Fiscal Crisis Makes the Economy a Little Shakier
When Congress continues to reach budget impasses, it makes every successive crisis worse
October 2, 2013 RSS Feed Print
The latest fiscal fight, the government shutdown, hasn't fazed markets.
The seasons change, the sun rises and sets, and Congress gets into intractable fiscal deadlocks.
At this point, the phenomenon of lawmakers getting embroiled in fiscal battles that threaten the economy has almost become commonplace.And that uncertainty could be making each successive crisis a little bit worse. If markets assume Congress will reach resolution as it has so many times before, it could have disastrous effects.
So far, investor reaction to the latest impasse has been small. Though the Dow Jones Industrial average dropped by more than 100 points Monday as a shutdown loomed, it gained much of that ground back on Tuesday, the first day that many government offices were closed. Likewise, Wednesday morning, the Dow started by losing 140 points but gained 50 points back by market close.
"If the stock market continues to have days like [Tuesday], where it was up or even marginally down, I don't know that that puts the kind of pressure that lawmakers need to see before they would act," said Mark Zandi, chief economist at Moody's Analytics, in a Wednesday call with reporters. "I think we need to see a day, maybe a couple days of pretty significant declines in the stock market...before lawmakers get the message that this is a real problem."
Though it could mean a lot of pain for government workers stuck at home, a few days of the partial shutdown shouldn't pull growth down. But the longer it takes markets to get the message – and to send a message back to Capitol Hill – the longer the shutdown may drag on, say some economists.
That prospect is made exponentially more scary with a debt ceiling deadline fast-approaching as soon as Oct. 17.
"The problem this time is markets are used to people in Washington screaming, 'Oh my goodness, we're going off the cliff,'" says Justin Wolfers, professor of public policy and economics at the University of Michigan. "They've stopped paying attention to that. As a result we're not yet seeing financial markets substantially enough concerned about the debt ceiling. And that raises the possibility of Congress doing something reckless, because markets aren't giving them the wake-up call they've given them in the past."
"Reckless" action, like not raising the debt limit, could have effects that are, quite literally, unimaginable. The nation has never defaulted before, and if that should happen this time around, there's no telling exactly how it would play out. It could mean a spike in interest rates, making borrowing for businesses and homebuyers – not to mention the U.S. government – much harder, and potentially dragging the nation into recession. Even tiptoeing over the limit could shake confidence in the U.S. economy.
"Even if [lawmakers] decide they're going to raise the debt limit on the 18th or 19th or 20th of October, they will have done significant damage, and that will show up in the economic data," Zandi said.
Similarly, individual investors have remained calm in comparison with 2011.
"So far, the market reaction has been muted, especially when compared to the debt ceiling debate in 2011," says a Wednesday note from investment banking firm Keefe, Bruyette, & Woods.
In the weeks leading up to and following the 2011 debt ceiling debacle, the Dow fell by 14 percent. Stocks have slipped slightly in the past week, but it is uncertain how they will fare ahead of a debt limit crisis.
True, there are a few reasons why investors may be less shaky than in 2011. The U.S. and global economies alike have healed since then, and European debt crises in particular are not the threat they once were. In addition, rating agencies do not appear to be ready to downgrade the U.S. credit rating, as they were in 2011.
Still, whether the economy is in sorry shape or slowly recovering (as it is now), the possibility of hitting the debt ceiling could be disastrous. And analysts at Keefe, Bruyette, & Woods believe volatility in the stock market will pick up as Oct. 17 approaches.
Then again, thinking about Congress' decision-making simply in terms of what Wall Street thinks would be a mistake, says one analyst, as lawmakers tend to focus closely on public opinion.
"If investors worry, then maybe the public will worry, but I don't think we need to have a sharp volatile market to get lawmakers to do things," says Gary Thayer, chief macro strategist at Wells Fargo Advisors. "I think they're watching public opinion just as closely as the market."
In the end, if Americans keep their eyes on their 401(k)s and the evening news long enough, they might reflect market sentiment as well as any stock ticker.
"As soon as people lose money, they're going to scream very loudly, and that's going to light a fire, I think, under lawmakers," says Zandi.
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