How Does a Government Shutdown Affect Investments?

The stock markets do not like uncertainty and a government impasse leading to a partial shutdown leads to uncertainty.  People begin asking questions like: How long will it last?  Who will be affected?  What are the long-term consequences?  The day before the shutdown that began October 1, the Dow Jones Industrial Average fell by 129 points.  Traders said that the markets had been anticipating the political gridlock, which had contributed to the Dow’s recent slide.  The day the government actually shut down, the same index rose 63 points because positive economic news impressed investors more than the shutdown.

Despite the size of government and the number of people they employ, the economy as a whole has a much greater effect on the markets than a shutdown.

During a shutdown, money still flows into the Treasury Department via things like tax receipts and it still flows out via things like Social Security and interest payments on Treasury Bills.  The military, weather service, food inspections, border control, air traffic, prisons and even the U.S. Postal Service (“Neither snow, nor rain, nor sleet, nor hail, nor government shutdown shall keep the postmen from their appointed rounds”), they all keep operating.  And as long as the Treasury Department still has flexibility, it still pays the debt as it comes due without missing a beat.  The interest on the debt runs about $220 billion while tax revenues exceed $2.5 trillion, so there really is not a chance that the U.S. government will actually default.

The government purposely tries to make a shutdown much more painful than it really has to be by, for example, closing the National Mall, the World War II Memorial and other open air monuments and attractions in Washington, D.C., in an effort to get the public to put pressure on Congress to reach a settlement.

But if you need a passport or want to get into a national park (via a park entrance, anyway), you are out of luck.  Non-essential federal workers get furloughed and non-essential services stop.

You’ll surely hear certain analysts, pundits and politicians saying a shutdown will hurt the economy, but if history is any guide that is hard to prove.  Recently, The Washington Post listed every shutdown – there were 17 of them from 1976 to 1996, spanning a total of 110 days – and of those 110 days only 6 were during a recession.  That’s very few considering that the U.S. was in a recession about 14% of the time during those twenty years.

The last, and longest, shutdown doesn’t appear to have hurt the economy either.  That was mid-December 1995 until early January 1996, a three-week shutdown under President Clinton.  The year before the shutdown, real GDP grew 2.3%.  In the fourth quarter of 1995 it grew at an annual rate of 2.9% and then during the first quarter of 1996 it grew at an annual rate of 2.6%.  This was despite the shutdown and the East Coast Blizzard in January 1996, which was then followed by large floods.

Remember the dreaded sequester?  It was forecast to be an economic and political disaster.  Today few people actually remember it because most never felt it.  Paradoxically, the real result of sequesters and shutdowns may be the realization by the public that the government is spending and wasting too much, and that political wrangling by the two parties in charge does not help the economy and may actually hurt it.  In the late 1990s, that reaction slowed government spending relative to GDP dramatically and the U.S. eventually moved into a surplus.

In other words, if you look back at history and didn’t know beforehand when the government was in a shutdown, you would be hard pressed to ever figure it out.  Keep this in mind as politicians, journalists and pundits work overtime in the coming days trying to scare investors and the public with the ramifications of keeping the government shut.  In more ways than one, it may be a good thing.

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