Don't Fret about the Potential Closure of the US Federal Government

What would Josh Lyman do?

Without a compromise, the US Federal Government may close down over the weekend. (Personally I am hoping for a West Wing-esq resolution) This is more a story of inconvenience for some services that may be disrupted and political theater than substantive political,financial or economic risk. Even the furloughed government workers are likely to be paid retroactively.

While not exactly sure what credit default swaps on the US really reflect, but it is interesting to now that the 5-year CDS was trading at the lows since August earlier today, according to indicative pricing. Some large money managers who reportedly cut their Treasury holdings also acknowledged earlier this year that they were selling CDS on the US, not buying, apparently as a way to raise cash and have some exposure to the US market.

In any event, the closures of the government for 5 day in Nov 1995 and then about three weeks from mid-Dec 95 through early-Jan 96 were not significant from an economic point of view though it had important political implications as the Republican Party was generally blamed.

The difference between the Republican and Democrat negotiating stances are minor--around $20 bln--with about $760 bln of spending planned in the remainder of the current fiscal year. The nature of the political climate requires brinkmanship so each side can ensure its constituents that it got the best deal it could.

Another way this is the hubris of small differences is that the real challenge with the US fiscal situation is not the headline grabbing discretionary spending, but the mandated spending. The real battle is not really about the current year's budget, but the structural deficit. Both sides appear to be jockeying for position in the public's mind for next year's high political stakes, which of course include the presidency itself.

Given what some times appears to be a lack of understanding about the US presidential system for those more familiar with parliamentary systems, the closure of the government would not do the dollar any favors. That said in the previous closure of the government in the late 95-early-96 period the dollar was generally firm and, if anything, trending higher.

To be sure, it is not that the closure of the government is good for the dollar, but rather there are other considerations and that the closure of the government is more about political theater than substantive economic issues for medium term investors.