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Mid last week, Congress passed a bill to avert a government shutdown for the second time in 2023, allowing spending to continue according to last year's approved spending plan, giving the country's leaders more time to hash out their disagreements on the budget for the next fiscal year.
My question is, why is this happening every few months? Why does the world's largest economic power and the symbol of democracy go through this seemingly humiliating shutdown process? And of course, what are the implications for people, our economy, and stock market investors like you and me?
Let's talk about that!
I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.
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What does the government shutdown mean?
First thing first, let's set the stage for today's discussion by clarifying what a government shutdown means.
Every year, federal agencies and programs receive an annual budget that Congress approves. Congress passes the budget each year, and the President signs it into law. There are 12 components of legislative bills in the annual budget. Each one is associated with one of the sub-committees of the Appropriations Committees in the United States House Committee on Appropriation. Basically, the House of Representatives and Senate have a committee that reviews and approves the government's budget each year in 12 different categories. The bill this Committee passes regulates the government's expenditure each year.
But, those 12 bills do not cover the government's spending.
What happens when the government shuts down?
The government has two types of spending: Mandatory and Discretionary. Mandatory spending represents two-thirds of the government spending and does not require annual voting. For example, military operations or social security payments, the Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve are deemed essential operations and won't be subject to government shutdown. Even if we talk about a full shutdown, it has nothing to do with two-thirds of spending.
The remaining one-third of the spending requires annual voting, the topic of those 12 legislative bills. For example, while the military would continue protecting the country as an essential activity that is differently funded, it may not be able to conduct its recruitment events as planned because those may be nonessential activities during a shutdown.
If Congress cannot agree on the discretionary bills by a specific deadline, the government shuts down its discretionary spending. The shutdown means no federal agency and program deemed nonessential can spend the discretionary budget until the bill is passed.
But why is this happening to the U.S. quite frequently, and why can't we get it together as a nation and avoid it?
Why, every few months, does this happen in the U.S.?
(source)On the surface and optically, it appears that the United States is the only country that cannot govern itself, and the leaders aren't capable of achieving alignment. We have had 10 full or partial shutdowns of discretionary spending in the last four decades. And that is only a U.S. phenomenon. Other governments in the world may only experience a shutdown when there is a revolution, a natural disaster, or an invasion. That's why when the world hears about a government shutdown, naturally everyone reacts with horror. We've even seen credit rating agencies such as Moody's and the Fitch rating referencing government shutdowns as a reason to reduce the country's rating.
But hang on!
As fundamental investors, we don't take everything we hear at its face value. We tend to dig. If you dig into this matter, you'll realize the reason this is happening to the U.S. is structural and the direct result of the U.S. government's design.
The reality is that the government continues to operate in the rest of the world even if their legislative body can't agree on the budget. Moreover, according to BBC, in most European democracies, the parliamentary system ensures the same party or coalition controls the executive and legislative bodies. This structure ensures there is no political misalignment that leads to shutdowns.
In the rest of the world, if the parliament does not approve the head of government's budget, it triggers a new election, not a government shutdown. The government continues to run even in that scenario. In Belgium, the country had no elected government for 589 days between 2010 and 2011 and kept running normally.
Only in the U.S. and after 1980 have government shutdowns become a recurring event and are used by political parties as a bargaining chip. That's because, in 1980, the Attorney General of President Carter's administration made it much stricter to continue spending without a budget. Before 1980, if there was a budget gap, the U.S. government continued to operate as normal, like most other governments worldwide.
Therefore, the shutdowns result from the difference between government structure and design in the U.S. and the rest of the world.
Like many things in the financial media, the shutdown isn't as wild and horrific a situation as the headlines make it seem.
But we can't ignore the effect the shutdown has on the nation. There are still undesirable and in some cases damaging consequences.
What's the impact on the nation if the government shuts down?
The obvious and immediate impact is on people employed by the government and nonessential programs. They won't get paid on time and for the time period of the shutdown, even though they will be paid once the government gets out of the shutdown.
Beyond people's salaries, the impact is not a clear-cut black-and-white list of what gets shut down or delayed. Because as the government goes through a shutdown, each affected agency has to work with the Office of Management and Budget (OMB) to set guidelines around what's deemed essential or nonessential.
In the past, quite a few social programs have been impacted. For example, during the 1995-1996 shutdown, more than 10,000 Medicare applicants were temporarily turned away every day of the shutdown. Many parks operated by National Parks remained open during the 2018-2019 shutdown, though no visitor services were provided, and damage and trash build-up were reported at many sites. In 2013, a backlog of 1.2 million income and Social Security number verification requests delayed mortgage and other loan approvals, and billions of dollars of tax refunds were also delayed.
However, the agencies have gotten a better sense of what is deemed non-essential over the years and during the last 10 government shutdowns in the past four decades. Therefore, mortgage and loan approval getting delayed again is unlikely. Those services have funds appropriated through the Inflation Reduction Act.
What's the impact of government shutdown on stocks?
Let's move closer to the business of investing and how shutdowns can impact the companies we all like and want to invest in. Immediate implications and macro effects may trickle down to the businesses.
The immediate impact can be on the company's revenue, any sort of governmental registrations, fundraising, and important policy developments.
These are all consequential impacts of a possible government shutdown. However, for the most part, the government shutdown has been inconsequential for the stock market as a whole, with a history of both positive and negative market direction during the last 10 shutdowns. These kinds of delays and impacts are quite short-term by nature. The longest government shutdown lasted 35 days in 2018–2019, which impacted tax refund delays, and even air travel traffic controls were impacted. But, it is very rare to say 35 days will make or break the future of any company.
The most important impact of government shutdowns
The broader impact of the government shutdown and perhaps with a more damning impact on the U.S. brand is how the world sees us. Before researching this post, I had no idea the shutdown resulted from the structural government design in the U.S. The chances are most people in the world aren't aware of that either. It looks bad that the government shuts down in the U.S. The overall U.S. economy and the perception of the stability and functioning of the country's government is an important brand value the U.S. has cultivated for decades. It doesn't help that rating agencies such as Moody's and Fitch ratings have already downgraded the U.S. government debt, seeing the government shutdown as a sign of governing challenges and an inability to reach agreements in a timely manner. Shutdowns are bad for the U.S. image. And that's bad for all companies that operate under the brand image and umbrella of the U.S. economy.
Talking about the brand image and the rating agencies reminded me of another post I published on Fitch Ratings' last downgrade of the U.S. debt. That's a good episode that goes with today's discussion. Link in the show notes.
I'll see you next time!