An Impasse Comes to Pass

Story Highlights:

• Fed officials deemed the US economy to be gaining traction while opting to maintain current easy-money policies—nothing new there.
• Congressional Democrats and Republicans continue to fight over budget plans for this fiscal year, and a partial government shutdown will result if it’s not resolved by Friday night.
• It should be noted the US government shut down in 1995 and 1996, which were great years for capital markets and the economy.
• The current impasse is over the size and nature of government spending cuts for the remainder of the fiscal year, but likely has more to do with political posturing.

The latest Federal Open Market Committee (FOMC) meeting in April proved to be quite vanilla. Minutes showed Fed officials deemed the US economy to be gaining traction while opting to maintain current easy-money policies—nothing new there. Fed policymakers also mulled over (but didn’t act on) plans for an eventual exit and recent rising headline inflation, though they noted longer-run inflation expectations remain stable.

More colorful has been the latest impasse between congressional Democrats and Republicans over budget plans for this fiscal year (ending October 2011). The budget battle, if not resolved by Friday night, will lead to a partial government shutdown as current authorized federal funding runs out. A last-ditch Tuesday meeting between President Obama and congressional leaders from both sides of the aisle failed to reach any sort of deal.

First, it should be noted the US government has shut down before over budget disagreements—in 1995 and 1996—and nothing disastrous economically came to pass. In fact, 1995 and 1996 were great years for capital markets and the economy, though the shutdowns did hurt the Republicans politically. A shutdown today in our view would be similarly uneventful for the economy and capital markets—though all sides have expressed keen desire to avoid one. It would likely first mean a temporary suspension of non-essential government spending (Treasury financing operations are not considered non-essential).

The current impasse is over the size and nature of government spending cuts for the remainder of the fiscal year. The Republicans want $61 billion, but the Democrats have only conceded to $33 billion. Additionally, Republican cuts would affect discretionary programs in areas such as health care, education, and environmental protection, while Democrats want cuts to come from benefit programs. Now, it seems a possible $40 billion target is being bandied about.

Meanwhile, adding fuel to the fire, House Republicans unveiled a budget proposal cutting about 5-6 trillion in spending over the next 10 years, including majorly reforming some programs like Medicare and Medicaid. The proposal is essentially a sweeping policy statement that’s already being rejected by the White House—and likely more intended to position the Republicans as extreme deficit-fighters and tax-reducers ahead of upcoming elections in 2012 than anything that will be realistically implemented.

Indeed, the whole budget battle is mostly political posturing, with both sides seemingly sticking to their ideologies. While the idea of a smaller government is nice—keeps more money in the hands of productive people (like you) in the private sector—budget resolutions aren’t even binding laws, but just enable congressional committees to draft relevant spending legislation. Even if Congress passes a budget with 10-year promises to do this or the other, it can get overhauled at any time—and typically does.

Plus, and unfortunately in terms of our overall federal budget, bickering about cutting $33 billion, $61 billion, or $40 billion is really just six of one/half-a-dozen of the other—these are relative peanuts. But peanuts to politicians are frequently powerful campaign fodder. So be it. Our guess is politicians eventually eke out some sort of agreement, realizing any government shutdown would mostly do more damage to themselves. Neither side will go down quietly, however.