What is happening in U.S.?

When one of my friends asked me what’s happening in U.S., so I thought of writing about it in a layman terminology, so that non-finance guys like many of my friends can understand.

Most of you might have already read or heard about American government being shut down from last one week or so. You might be wondering, what is this shut down. Why it happened and what is the impact of it?

To start with America follows the financial year from 1^st October to 30^th September just like our financial year, 1^stApril to 30^th March. For every new financial year a new budget is prepared and once it is passed, fund can be transferred to various departmental activities. Means funds allocated for each department can be utilized according to their plan of expenditure.

But if Congress (Parliament in Indian context) does not pass the new budget presented then Congress needs to come up with contingent bill, which allocates funds as per previous year allocation, to work around for time being. If that is also not passed by the majority in the both the houses of the Congress (Senate and House of Representatives) then government needs to shut down some departments which are not exempted from Anti-Deficiency Act (ADA). ADA is legislation, which prevents some government departments spending beyond their allocated funds.

You might be wondering why Congress didn’t pass the budget or contingent bill. Bill is implemented only when both the houses of Congress pass the bill by 2/3 majority or more. Senate, the upper house of the Congress is led by Democrats (52/100) and House of Representatives; the lower house of the Congress is led by Republicans (232/435). So bill should be satisfactory to both the parties.

President Barrack Obama is trying reform the healthcare (bill is also known as Obamacare) by reducing the cost of insurance and increasing the coverage of uninsured Americans (Around 15% of the population is not insured in America). But Republicans are opposing it for obvious political reasons and burden on expenditure, so not ready to negotiate in House of Representatives. President and Democrats are not ready to negotiate the budget without Obamacare. So because of the deadlock and new financial year U.S. government needs to shut down some of the departments until deadlock is resolved and pass the budget.

Now question is what is the impact of the government shut down? Immediate effect is around 8 lack government employees are on forced temporary leaves without pay and around 13 lack government employees need to work without pay. Major tourism spots like historical places, libraries and museums will be closed. And economic impact is different as per different estimations. According to Goldman Sachs estimates 5-6 days shut would shave off around 0.2% of GDP, 10-12 days shut would cost around 0.5% of GDP and 20-24 days will be of 1% of GDP.

So ultimate question would be what is the way going forward?  How long deadlock can continue? As long as both parties come to table with some amendments from both of their demands deadlock can continue. Historically the longest deadlock has been for 21 days in 1995-96. So what if present deadlock continues for more than 2-3 weeks like one in 1995-96? That’s the worst thing to happen to U.S. as it will be facing debt ceiling negotiation on October 17. Debt ceiling means, the limit on the amount of debt America can issue. If this deadlock continues till October 17 then there is possibility that debt ceiling may not able to increase. If that happens then treasury department may not able to repay the amount on debt maturities beyond a point, where it runs out of its reserves. After this treasury department needs to prioritise its debt service obligations and there might be partial defaults or in worst case full default, which is unthinkable and unprecedented! Because of the debt ceiling issue and the way it was handled in 2011, Standard & Poors downgraded U.S. from AAA rating.

Conclusion: Hope American politicians realise and recall the phrase “it’s the economy, stupid” and resolve the issues as early as possible.