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Stephen Lewis: Tel (0)20 7190 7193, or e-mail:sjlewis@monumentsecurities.com

Monument Securities LimitedRegistered Number: 2583440

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Economic Insights 4 October 2013, No.4154

Playing chicken

Mme Lagarde is the latest luminary to draw attention to the threat to global growth from failure to raise the US federal debt

ceiling. It is doubtful whether members of the US Congress will pay much attention to her warning. The Managing Director of

the IMF can have little standing with an elected representative from Texas. The chagrin of the global elite probably reflects, in

some small part, dismay that the smooth running of their system is so vulnerable to the actions of what must appear to them

to be a bunch of rednecks. However that may be, there is no denying that the repercussions of a US federal debt default are

literally incalculable but might reasonably be estimated as a substantial multiple of those that followed the Lehman debacle.

Republican extremists in the House of Representatives have been taking undue risks with the faith and credit of the US

government. But President Obama yesterday was also taking risks in a manner verging on the irresponsible when he exhorted

financial markets to show more anxiety over the government shutdown. He seemed irked that the US equity market, relying on

a record of strong performance after previous shutdowns, had been positioning for a rally rather than collapsing in a way that

would pressure his Republican opponents. If the market had taken his advice seriously, however, he could not have been sure

the scale of the sell-off would not have seriously destabilised the economy. In the event, yesterdays decline in US equity

indices was not large enough to intimidate Republicans, or presumably to meet the Presidents best expectations.

Mr Boehner neutralised some of the negative market impact Mr Obama had sought by letting it be known that he would not

allow the government to default. That did not mean, it turned out, that he was ready to bring a clean continuing resolution

to the floor of the House, not yet anyway. His objective was, rather, to allow defunding Obamacare to lapse as a bone of

contention with Democrats, in recognition of the reality that neither the Democratic leadership in the Senate nor the President

is going to budge on that issue. To do that without alienating a substantial proportion of Republican representatives, he would

need to win concessions in other areas where rank-and-file Republican feeling runs high. Consequently, he is proposing a

conference with members of the Senate to fashion a budget deficit reduction plan that might substitute targeted reductions in

welfare payments for the blunt instrument of the sequester. The more pragmatic elements within the Republican Right might

accept that as a reasonable switch in strategy. The danger for the Democrats, if they were to reject Mr Boehners proposal, is

that they might at least share the blame for any subsequent debt default. Mr Boehner would then claim that he had wanted to

avoid default but had been thwarted by the refusal of Democrats to enter into rational discussions on ending a sequester,

which all sides recognise to have been an unsatisfactory means of maintaining budget restraint. Leading Democrats in the

Senate, however, are already saying they will not negotiate with a gun to their heads. They are demanding that the House first

pass a clean continuing resolution and a clean bill to raise the debt ceiling.

Meanwhile, Federal Reserve policymakers are using the government shutdown and the threat of a US debt default to make the

best of the bad job that is the central banks communication policy. Mr Lockhart of the Atlanta Fed yesterday said that the

fiscal impasse had vindicated the FOMCs decision at last months meeting not to taper the Feds asset purchases. But he was

careful not to rule out of court Mr Bernankes June timetable for tapering, which saw a start this year and completion by the

middle of next year. Mr Williams of the San Francisco Fed also endorsed the Bernanke timeline on tapering. At the same

time, he said decisions would be completely driven by economic data, even though the government shutdown could make such

data scarce. He was worried about the impact fiscal wrangling might have on confidence in the economy. Mr Lockhart

declared that if the shutdown turned out to be protracted, it would have a measurable impact on 2013Q4 GDP growth. We

should note that, aside from the negative impact on confidence, the non-essential or, in politically correct parlance, the non-

excepted workers, who have been laid off, will need an Act of Congress if they are ever to recoup wages for the working time

they are losing. Even the excepted workers who are still on the job will not be paid as long as the shutdown lasts. It would

be surprising if federal workers did not rein in their spending, at least in October.

A key question is whether financial markets will go on believing in a twelfth-hour resolution of the fiscal conflict in Congress, or

whether, at some point ahead of the debt ceiling deadline, they will start to take Mr Obamas warnings of impending chaos

seriously. There can be no doubt that much might be at stake. The US Treasury is claiming that it could not prioritise federal

debt service payments over other outlays, though that attitude may well be no more than part of the Administrations

negotiating position. Servicing the debt as a priority certainly seems a more practical solution, if the Treasury really wanted to

avoid default, than the more fanciful suggestions of invoking the Fourteenth Amendment or issuing a trillion-dollar coin. The

truth seems to be that the US Treasury does not want to open up an avenue of escape from the impasse that would take

pressure off the Republican leadership. The intransigence of the parties in this dispute, if it is maintained, could lead markets

to begin to attach some weight to the possibility that a default might occur. After all, a default would have devastating

consequences, foremost in the derivative and money markets but spreading to all global financial markets. The situation offers

an interesting exercise in game theory.

7/27/2019 Economic Insights; Playing Chicken

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Stephen Lewis: Tel (0)20 7190 7193, or e-mail:sjlewis@monumentsecurities.com

Monument Securities LimitedRegistered Number: 2583440

www.monumentsecurities.com

The Economist Building25 St Jamess StreetLondon SW1 1HA

Tel: +44 (20) 7190 7222

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