Goldman Fears "Rapid Downturn In Economic Activity" If Debt Limit Breached

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The federal government has been partially shut down for 4 days, and it appears likely that the situation could continue for a while longer. As the shutdown continues, the political focus has begun to shift to the next deadline: the Treasury expects to exhaust its borrowing capacity by October 17. Goldman expects the Treasury’s cash balance to be depleted no later than October 31 and possibly quite a bit sooner.

After October 17, the Treasury can keep conducting auctions to roll over maturing securities, but it cannot increase outstanding debt. If the debt limit is not raised before the Treasury depletes its cash balance, Goldman fears it could force the Treasury to rapidly eliminate the budget deficit to stay under the debt ceiling. They estimate that the fiscal pullback would amount to as much as 4.2% of GDP (annualized).  

The effect on quarterly growth rates (rather than levels) could be even greater. If this were allowed to occur, it could lead to a rapid downturn in economic activity if not reversed very quickly.

Via Goldman Sachs,

Two Deadlines Lead to Uncertainty

Unless Congress raises the debt limit, Treasury will no longer be able to issue debt from October 17, and it will deplete its cash by the end of October if not before (Exhibit 1). Unfortunately, the deadline for action in this instance has become less clear than in previous debt limit debates, in part because much of the commentary on the debt limit has conflated two different deadlines.

The first deadline is when the Treasury will exhaust its borrowing authority. The Treasury announced in September that it expects this to occur on October 17, in line with the projection the Treasury released a month ago. Since this projection is determined mainly by Treasury issuance expectations and flows in trust funds, rather than on day to day fluctuations in cash flows, there is little reason to second-guess Treasury’s estimate.

By contrast, the Treasury does not project when it will deplete its cash balance, though many external organizations do. Since the Treasury usually aims to run a cash balance large enough to cover unexpected payment needs or a revenue shortfall, the Treasury expects to have $30bn on hand the day it exhausts its borrowing capacity. The Treasury views this $30bn as the minimum prudent balance in light of the significant uncertainty in daily cash flows, though there have been a few instances (unrelated to the debt limit) in which the cash balance has dipped below $15bn. Most external projections of the debt limit deadline focus on when this cash is depleted. Our own estimate implies that the Treasury could conceivably continue to make its scheduled payments until the end of October.

However, the Treasury’s cash balance is likely to be so low after about October 25 that, depending on revenue fluctuations, the cash balance could be depleted on any day. At that point, it is possible that the Treasury would need to cease making payments in order to conserve the little remaining cash they would still have on hand.

The partial shutdown of the federal government is unlikely to shift the date at which the Treasury depletes its cash by more than a couple of days in our view. The main effect of the shutdown would be to eliminate Federal employee compensation for non-exempted workers, which should amount to $400 million per day on average in reduced spending, or about $5 billion in reduced spending if it lasts until the October 17 deadline. It is possible that spending in other areas of the budget could slow, lowering spending slightly further.

However, it is very unlikely that the Treasury would see a large enough spending reduction to extend the date at which it depletes its final cash balance by more than a couple days. A number of large payments totaling around $60bn are due November 1, and it appears very unlikely that the Treasury would be able to make all of the payments scheduled that day absent an increase in the debt limit, regardless of the exact effect of the shutdown.

While we believe that congressional leaders take the October 17 deadline seriously, there is nevertheless a fair chance that Congress might not pass legislation to deal with the debt limit until after that date, because of the expectation that the $30bn cash balance the Treasury projects could be used to meet obligations for several more days. While this is probably true, if Congress does not increase the debt limit by the October 17 deadline, we would expect markets to interpret this as an increased risk of missed payments, potentially resulting in much more disorderly market activity than we expect to occur prior to the deadline.

Growth, Not Treasuries, Ultimately at Risk in a Debt Limit Mishap

Failure to raise the debt limit would eventually lead to a sharp reduction in spending and could result in a rapid downturn in near-term economic activity. A very short delay past the October deadline—for instance, a few days—could delay the payment of some obligations already incurred and would create instability in the financial markets. As noted in prior research, this uncertainty alone could weigh on growth.

But a long delay - for example, several weeks - would likely result in a government shutdown much broader than the one that started October 1. In the current shutdown, there is ample cash available to pay for government activities, but the administration has lost its authority to conduct "non-essential" discretionary programs which make up about 15% of the federal budget. By contrast, if the debt limit were not increased, after late October the administration would still have authority to make most of its scheduled payments, but would not have enough cash available to do so.

Using our cash flow projections as a guide, we estimate that the revenues the Treasury will receive in the month following the October 17 deadline would equal only about 65% of spending going out, implying a far greater fiscal pullback than will occur as a result of the ongoing shutdown. In essence, a prolonged delay would force the Treasury to rapidly eliminate the budget deficit to stay under the debt ceiling. (The deficit has significant seasonal fluctuations and CY Q4 is normally a higher-deficit period, offset by lower deficits or surpluses in other periods, particularly CY Q2.)

We estimate that the minimum pullback in spending that would be required to remain under the debt limit for one month without an increase would be equivalent to 1.7% of GDP (annualized).14 However, if the Treasury decided to set aside interest payments and make other payments in arrears, we estimate it would result in a pullback in primary (i.e., noninterest) outlays of 4.2% of GDP (annualized). In both cases, the effect on quarterly growth rates (rather than levels) could be even greater. If this were allowed to occur, it could lead to a rapid downturn in economic activity if not reversed very quickly.

 

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