So, this week the US avoided a historic default on their debt, with US President Barack Obama passing a bill that ended a 16-day government shutdown. What this really means for the layman is significant: everyone can go watch the Panda Cam at the Smithsonian again (I’m sure we in Singapore can all empathise, eh?). While we won’t know fully what economic calamities would have befallen us should the default have happened, an explanation of the shutdown and some basic preparations for the near future are in order:
Quickie Explanation: How Does a Shutdown Happen Anyway?
There are two general models of democracy: the Washington model, and the Westminster model.
Each model divides government into three arms:
- An executive (proposes new plans, policy shifts, laws, etc.)
- A legislature (either accepts or rejects what the executive proposes)
- A judiciary (once the proposals are passed by the legislature, these guys enforce them)
The division of power ensures that no single arm of government can seize control of the country. The executive can only propose, but not approve. The legislature can only approve, but not propose anything new, etc.
In the Westminster model (which Singapore follows), our executive and legislature are joined. Our executive (the Prime Minister and his Cabinet) also get to vote in Parliament. So they can both propose and approve.
That’s different from the Washington model. President Obama (the executive) is separate from Congress and the Senate (the legislature). The US President doesn’t get to vote in either of those. So he couldn’t just step in and force his budget through.
Also, the US has a bicameral legislature. For President Obama’s proposals to be approved, they have to be okay’ed by both the US Congress and Senate*. It’s a bit tougher than Singapore’s unicameral system, where Parliament is our only layer for approval.
Right now, President Obama has majority support in the Senate, but not in Congress. Hence, his budget got blocked. The conservatives in Congress didn’t want to fund his healthcare scheme, so they threatened to keep the budget blocked until the President backed down.
(*Congress has proportional representation. The bigger the state, the more representatives it has. The Senate has just two representatives per state, regardless of population.)
What are the Consequences?
The budget funds the civil service in the United States. Blocking it threatened the pay of several hundred thousand civil servants, including those in health care, emergency services, administration, etc.
The wider threat, which has now passed, was debt default: if the budget hadn’t passed, the US debt ceiling wouldn’t have been raised. This would have caused some US debts to be written off, and further downgrade the country’s credit worthiness.
What is the Impact?
Did you invest heavily in equities or the US dollar? If you did, it was like having the train you’re on hijacked by morons who can’t drive it. Even though the shutdown is over, there are ripple effects:
- It impacts QE tapering
- It may funnel investments into emerging markets
- Potential rise in market volatility
- May drive further investments into gold
1. It impacts QE tapering
Quantitative Easing (QE) is a US fiscal policy that’s meant to stimulate their economy. This is mostly done by aggressively buying back US Treasury bonds, hence putting more US dollars into circulation.
QE was expected to “taper off” this year, as the US economy improved. But the shutdown may have stalled that. Broker Jeremy Foo says:
“While their government is shut down, they don’t have anyone running the data. And so as long as they have no economic data, they probably won’t decide to initiate QE tapering. The shutdown may have stalled QE tapering from 2013 to 2014. That could keep interest rates (He means for loans – ed.) down for a while more.”
2. It may funnel investments into emerging markets
With the US looking more and more like a three-legged horse, some investors have begun looking for alternatives.
“I have shifted some of my investments to Emerging Market (EM) bonds,” investor Eugene Poir told me, “Even with the shutdown over, you can see the interest rates on US treasury bonds are rising. It will be very much more expensive for the US to borrow now.
I think now the US is not infallible like we imagine. At least with EM bonds I know the risk comes with better returns. With the US, I don’t know. Returns are not as good, and we can see this sort of crisis also happens.”
3. Potential rise in market volatility
Jeremy seems to echo Mr Poir’s sentiments, on the issue of risk aversion. Expect some wild swings in the market, in the coming months.
“The government in the US has just gotten back up, and companies are still tallying the costs,” Jeremy says, “If there has been an impact in someone’s supply chain, or sales were affected, we will find out in short order. Expect to see that whipsaw pattern on your charts…”
(Whipsaw = when a security’s price rises or falls quickly, and then moves back to its original price just as fast)
4. May drive further investments into gold
Gold enthusiasts are already jumping on this. It’s more historical evidence to suit their investing beliefs. Charlie Sng, who avowedly invests only in property and gold, says:
“This is another reason you should not invest in paper money. Even the world’s most secure currency is subject to this kind of risk. In a matter of weeks, something you have no control over can wipe you out.”
Admittedly, that’s a bit of an extreme view, but Jeremy admits that:
“It does present a case for gold or other alternative investments. Just diversify your portfolio. Don’t put all your eggs in one basket, because you cannot predict when this sort of crazy thing will happen.”
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