Government Shutdown Commentary

Yesterday, Mitch McConnell instructed Senate Republicans to block debate (via filibuster) of the bill to increase the debt ceiling, sending the markets into decline today. Without Congressional action a US government shutdown is looming and the US will default on debt obligations in mid-October.

Some Q&A – as with most things financial, it’s a little complicated. As usual, I will provide some background and context.

What is the history of voting to increase the debt ceiling and what is it for?
Congress holds the purse strings for the US Budget. Prior to WWI Congress had to approve every bond issuance the Treasury put out to borrow money . The government borrows money by selling bonds.
During WWI Congress voted to instead approve an upper limit of borrowing to provide the Treasury with more flexibility and reduce the frequency of voting. Everything hummed along smoothly until the 1970s when the debt ceiling vote shifted from a routine bipartisan administrative function to a showmanship political issue.

Aren’t the Republicans trying to reign in uncontrolled future Democratic Spending?
No, absolutely not. The debt ceiling is about fund spending approved in the past. This is just political theatre, let me explain:

1. The budget was previously passed laying out the expenses of the government and the tax plan for a set period moving forward. The tax plan is the revenue, or income. Just like my household and yours, there is income and expenses.
2. The last Administration and Congress (House and Senate) approved a budget with increased spending, and reduced revenue with the tax cuts, adding $7.8 trillion to the debt, $3 trillion of which was related to COVID. The deficit when Biden took over was $28 trillion or double the 2016 level. To be clear, the Republican majority in the Senate approved this increased deficit spending for the future back when Paul Ryan was Speaker of the House. We are now voting to fund this previously passed budget. This has nothing to do with funding the current administrations budget proposals (The Infrastructure Plan) which have not been approved.
3. Basically, the current Congress must increase to the debt to pay for the previous President and Congress’ budget. Yes, that is a strange practice.
4. This week is time for Congress to vote to increase the debt ceiling to pay for the $7.8 trillion of deficit spending approved in the past. While politics today certainly are different in America right now, we can only look to the past brinkmanship deployed and the eventual caving by the Republicans each time for guidance. As with many other showdowns, a number of Republicans calling to block the approval of the funding of their party’s budget from the last administration are currently putting forward standalone bills to fund projects in their districts or states that would require future increases to the debt limit. I take this as evidence that these Republicans may vote to increase the Debt Ceiling as they have every previous time. However, if the Republicans continue to block action and cause the government shutdown, the Democrats may pass the increase via Reconciliation (call me for explanation, this is long enough).
5. Again for clarity, increasing the Debt Ceiling is approving the ability to pay for a budget already passed. Yes, this is silly and we are one of only three countries in the world that do this.

Thanks for the history lesson, but what about my portfolio?
While optimistic about the markets and the economy, we have fared well through prudent and cautious action. Where appropriate and investment policy statements allow, portfolios have been backed down by the amount of equity exposure because of continued COVID and supply chain concerns and the types of bonds that may be most affected by rising interest rates – not due to concerns of a government shutdown.

Past government shutdowns are like potholes that the markets barely notice. Those who feel the most pain are government employees who may be forced to work, but not be paid. Since 1976 there have been 22 incidents like this.
 

S&P Performance During Past Government Shutdown

Over the last 20 government shutdown, the market split evenly between rising and falling slightly during them. They are common enough that the markets “know” the world keeps spinning, companies stay open, and everyone keeps going to work (except some government workers and contractors serving the government, for whom this is deeply concerning).  The market knows theatre when it sees it.