US economic stalemate

Friday, October 11, 2013

US economic stalemate

Why and how it will affect other economies

While the US may be exceptional due to a variety of reasons, one particular reason Americans are not feeling proud of - is their leaders' ability to shutdown the government. Following a long drawn conflict over the Affordable Care Act (colloquially called Obamacare), the Republicans have refused to ratify the federal budget, thus depriving the government of the resources it needs to continue running. While the politics itself is extremely complicated, our interest lies with the impact it will have on the world economy since the US economy is vital to the global financial system.
Image credit: radiantskies / 123RF Stock Photo

To understand this; however, we need a quick review of the impact the US shutdown will have on the US economy since the impact on the world will be an indirect effect of these -

·         Funding to departments and sections deemed “non-essential” would be stopped. This would result in a huge percentage of federal workers being “furloughed”, meaning asked to sit at home without pay.
·         Commodity and services demand from the departments will stop.
·         National parks, museums, etc will be closed, thereby affecting tourism
·         Even basic services like border-post management, visa application processing, etc may be affected if shutdown is prolonged
·         Publication of critical reports, such as Employment Reports, will be delayed.

While not all of these affect any single country or economic sector, a combination of some will possibly affect all. Here, we will focus on those weighty economies/economic zones which will be largely affected -

1.       Canada – Canada is most likely to suffer from the shutdown as it is both economically and geographically most proximate to the US. Indeed, a major part of its exports and imports are dependent on the US. Since these depend upon the huge border that the country shares with US (the longest peaceful border in the world), any disruption of the border crossings will directly affect the Canadian economy. Added to these are fears that the work visas needed by entrepreneurs and professionals for working in the States will get delayed due to the furloughing of “non-essential” staff.

                Further, the cut in government spending which will be part and parcel of the US shutdown, will                 reduce demand for Canadian goods at a time when rising competition and lower demand for    exports and slow domestic growth have already subdued the Q3 economic data. In the short run, even more dangerous than the actual reduction of demand will be the shattered investor confidence caused by the fear of falling demand and uncertainty surrounding a shutdown in the richest country in the world. These together lead to a rise in unemployment. Dan Kelly, president of the Canadian Federation of Independent Business, summed the situation nicely, “Anyone who has dealings with the U.S. will be a little bit nervous and the economic impact this could have could affect us all,”

2.       Australia – While Australia is as far from US as Canada is near, the economy is equally jittery. Here, fears center on the rise in the Australian dollar (AUD) compared to the US dollar (USD), as confidence in the US greenback is undermined. This would drive up costs of Australian exports to the US for the American consumer. Since large portions of the federal workers stand furloughed, and, therefore, more likely to put off non-essential purchases anyway, the rise of the AUD bodes ill for the Australian economy.

                Further, there are fears that the negotiations going on in Congress could eventually lead to         greater austerity, especially if the upcoming debates on raising of the US debt ceiling get stuck, as well. This would reduce demand for Australian products in the long run, thereby hurting the economy to a much greater extent.

3.       Asia – Asian markets responded with caution to the news of the shutdown. On one,  hand, there are concerns regarding the tapering of demand from the US. Further, economists fear that the stoppage of reports, such as the Employment report, would prevent them from predicting the future trends in demand. This is a pertinent concern since it was after all poor employment data which persuaded the Fed to put off QE3 tapering, thereby allowing the Asian markets to continue receiving the FII investment.

                However, with the shutdown set to undermine the US economy to the extent of cutting off about half a percentage point of GDP growth, the Fed is even more unlikely to taper off the QE3. As Nizam Idris, head of fixed income and currency strategy at Macquarie Bank Ltd in Singapore noted in the context of Malaysia, “The absence of agreement on the fiscal front, led to the market thinking that it will mean the third round of quantitative easing will be sustained for a bit longer. There’s a lot of foreign demand for Malaysian government bonds”  Thus, there is both hope (of  QE3 continuing) and fear (of lower demand and uncertainty) in the Asian markets. 

4.       Eurozone – Like Australia, Eurozone's fears primarily center around trade. With the fall of the US dollar, the Euro has ended its falling streak, and there are fears that its rate will now rise to the dollar. This directly affects exporters, since they had anticipated an exchange rate of $1.30 - $1.32 per Euro, based upon the steady rate the currency maintained for much of 2012. If the Euro now rises, these exporters will have to suffer losses.

                Further, since the European Central Bank’s monetary policy is not as liberal as that of the Fed, there might be an additional price that exporters will have to pay for purchasing Euros for future delivery. Finally, the reduction of demand caused by the stronger Euro will directly affect countries such as Spain with higher unemployment rates. Finally, since inflation is at a low level, the high Euro won't serve any purpose other than stifling demand.

From the above analysis, it becomes clear that the US shutdown, though in essence a purely US development, has already led to uncertainty and confusion in many markets. Fears relating to the falling dollar, problems of the border post management and visa processing and delay of key government reports, are already haunting markets.

Though there is some optimism in Asia regarding the further reduction of the possibility of a QE3 tapering, the overall mood in international markets is one of increasing worry. This is set to worsen as experts fear that a prolonged shutdown would seriously affect the US economic recovery, and thereby further push down demand. As such, the whole world, along with all of America, is praying that the US political leaders see sense and sort out the deadlock at the earliest.

Author: Aritra Mazumdar

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