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The Good, The Bad, & The Ugly (in the U.S.)

October 15, 2013

At the time of this writing, the government is on its 14th day of a partial government shutdown, and there appears to be little progress toward an agreement on the debt ceiling. As investors we have no control over the outcome! We are forced to sit tight and watch the seemingly juvenile behavior of politicians. As there have been no outcomes yet, we can only share some thoughts on what we see as the good, the bad, and the ugly as things stand today.

The Good
There are lots of good things going on in our country which have brought about the stabilization of our economy and the addition of millions of private sector jobs in recent years. To name a few:

  • Use of new technologies (e.g. 3D printing)

  • Energy boom

  • Return of manufacturing to the U.S.

  • Consumer spending and confidence improvements

  • Housing recovery

These will all have significant impacts on our economy over the coming years. In the backdrop, things are also getting better outside the U.S. with China seeing growth solidify, Japan seeing increased demand, and Europe moving out of recession.

The U.S. fiscal situation has also been improving as our deficit as a percent of GDP has been cut by more than half since 2009 thanks to lower spending due to sequestration cuts and stronger-than-expected tax receipts.

The Bad
Despite the dysfunctional manner in which politicians are choosing to go about the recent budget debate, they are actually dealing with what everyone knows are long-term fiscal problems.

Budget:Obviously, it is a bad situation that the government has shutdown and is being used in political negotiations. It is creating a lot of noise, but unless the shutdown lasts more than a couple of weeks, the impact on stocks or the economy will likely be minimal as it was the other 17 times that the government has shut down in the past.

Debt Ceiling: It is also not a good thing that the U.S. has nearly hit the debt ceiling again and that the government has used about $150 to $200 billion of borrowing tools known as "extraordinary measures" since the last debt ceiling increase on May 19th, 2013. Nearly all of these extraordinary measures have been exhausted, including the Government Securities Investment Fund (about $160 billion) and the Exchange Stabilization Fund ($23 billion). In addition, to remain below the debt ceiling, the Treasury has suspended the issuance of its State and Local Government Series securities, as well as certain payments to the Civil Service Retirement and Disability Fund.

The Ugly
A full default on our debt
would be the very ugly and unrealistic outcome that the media likes to tout. Some have also cited we might sell our gold reserves or not pay beneficiaries. We do not think any of this will happen. Since the number one goal for any politician is to get re-elected, it is unlikely that the situation will go that far.

In addition, even if Congress fails to raise the debt ceiling by October 17th when the borrowing limit will be reached, it does not automatically mean that the U.S. will default.

  • The government would still be taking in more revenue (about $200 billion in October) than it owes on bond interest payments ($25 billion), and the Treasury could access the bond market to roll over any debt that is maturing.

  • Compare that to the troubled nation of Greece in recent years that was truly in danger of defaulting because it could not issue any new debt to roll over maturing bonds.

If we fail to address our fiscal issues and put the U.S. budget on a sustainable long-term trajectory, we will have ugly consequences to face down the road. In the short run, however, the budgets for this year and next year are in a much better position than they were a year ago. The bottom line is that this is a political issue - not an economic issue.

In the coming days, we are likely to see a showdown and some short-term agreements on the budget and the debt ceiling. This will hopefully pave the way for further negotiations on the longer-term fiscal situation.

KEY TAKEAWAYS

  • The budget negotiations, government shutdown, and debt ceiling debate are all political issues - not economic issues.

  • There are many positive things driving economic and job growth today such as energy, manufacturing, and new technology.

  • The government shutdown is likely to have little overall economic impact.

  • Even if the debt ceiling is reached, the government would not automatically default the government takes in more revenue than it owes in interest payments.

Sources: First Trust Advisors, Fidelity Investments-Market Perspectives, Nuveen Asset Management

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  • The Good, The Bad, & The Ugly (in the U.S.)