The purpose of this report is to examine the impact of a U.S government shutdown on private asset markets. The method used to produce this analysis is the balance of sectoral flow model after the work of Professor Wynne Godley.
The threat of a U.S. government shutdown is once again upon us. President Trump has made it known that unless lawmakers allocate funding for a wall between the U.S. and Mexico, he will induce a U.S. government shutdown until they do.
In United States politics, a government shutdown occurs when Congress fails to pass or the President fails to sign appropriations: legislation funding federal government operations and agencies. This basically means that the U.S. government will reduce spending into the economy during the debate over the new U.S. government budget.
October is the first month of the new 2018/2019 fiscal year. The new budget for the new year has not yet been ratified, and the Federal government gets by on interim funding bills until it is. This process of interim measures and then the final budget ratification gives the President the power to block legislation and cause a government shutdown due to new funds for operations not being authorized ahead of expenditure. It you are a private enterprise and have just provided goods and services to the U.S. government in good faith, it is no laughing matter when your invoices go unpaid for a time.
The good news is no shutdown has lasted longer than a few weeks.
Balance of Sectoral Flow Analysis
Professor Wynne Godley first comprehended the strategic importance of the accounting identity, which says that measured at current prices, the government's budget balance, less the current account balance, by definition is equal to the private sector balance.
GDP = Federal Spending [G] + Non-Federal spending [P] + Net Exports [X].
As a percentage of GDP, all three sectors sum to zero and balance each other out.
A table of the sectoral balance flows is presented below:
(Source: FRED plus author calculations)
*Estimate to be updated when the end-of-year numbers are known.
#Forecast based on existing flow rates and plans.
A U.S government shutdown means that the "G" in the above equation will be reduced from "normal" levels.
The chart below shows Federal government expenditures. On average, the Federal government spends $65 billion into the economy each month (For the previous 2017/2018 fiscal year, net expenditure was $779 billion / 12 = $64.91 billion per month).
The impact of a shutdown will be an expenditure of less than this amount in the going forward. The months going forward may even see an extraction of money from the economy such as occurred in January, April, and September of this year.
The chart below shows the stock market over the same period:
Comparing the charts above, one can see the impact on the stock market:
- The impact of the surplus budget drain in January 2018 was felt in February, when the stock market retraced 10%. Adding to this drain was a large current account deficit for the same quarter, and that got larger in the following quarter as well.
- Federal government spending resumed at a healthy $200 billion per month in February and March 2018, and helped the stock market almost make a "V"-shaped recovery.
- A huge $200 billion surplus budget in April 2018 put an end to the "V"-shaped recovery.
- As expected, the Federal government spending resumed and was a steady net add into June, July, and August 2018 as the stock market rose.
- In September, the rising pattern of fiscal flows was broken by a $119 billion Federal government surplus and also a decline in credit creation by commercial banks. The result has been a stock market retracement.
- The resumption of Federal deficit spending, together with a rebound in credit creation by commercial banks, have seen the stock market make a recovery from the October plunge, and it is now retesting the previous low.
- There is a one-month transmission lag between changes in the net money supply and movements in the stock market.
Impact On Fiscal Flows
The Federal government's net budget expenditures for October 2018 show $100 billion was added to the economy. If there is a shutdown, this net add to the economy would be much less or even negative.
The longest shutdown in recent history was in December 1995 to January 1996 and is shown in the chart below.
It shows the dent put in Federal fiscal flows to the private sector.
The chart below shows the impact on the Wilshire 5000 index of the same period and a corresponding dent in the index at the same time.
A similar growth "flat spot" can be seen in the S&P 500 over the same period, as shown in the table below.
Let us assume that when the shutdown occurs, the Federal government spends no money in that month.
The balance of accounts would look like this for the private domestic sector balance:
[P] = [G] + [X] is an accounting statement of fact.
Inserting the numbers:
[P] = [$0 billion]+[-$39.2 billion*]
*Estimate: The current account deficit is -$353.6 billion for that last three quarters, and this works out to -$39.2 billion per month.
[P] = -$39.2 billion net deduction.
This means that the private domestic sector, where the stock market is located, deflates by $39.2 billion during a shutdown. Under such circumstances, the stock market can be expected to decline, or at least not grow, during this shutdown period.
Conclusion, Recommendation and Summary
What is an investor to do under such circumstances?
Those with cash to deploy can use the dip to buy stocks that might be on their watch list and might be trading at a discount due to an overall deflation in fiscal flows and sentiment caused by the shutdown.
Those who are invested would be advised to wait out the dip or flat spot in the knowledge that the shutdown will pass, and often there is boosted expenditure afterwards to make up for the shortfall in spending. Certainly, a shutdown is not on its own a reason to panic and sell. Stay the course is the best advice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.