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House of horrors? Shutting down D.C. has its upside

Leave it to those perpetually feuding politicians to gum up a decent market rally and put an economic recovery at risk.

Fears of a U.S. government shutdown over the latest budget impasse in Congress were already roiling markets when former Italian premier Silvio Berlusconi did his best to add to investor worries in Europe by pulling the plug on his party's participation in Italy's shaky coalition government. As one currency analyst opined: "Farce reigns and risk aversion rises."

The looming shutdown in Washington prompted dire warnings of steep cutbacks, higher unemployment, weaker economic growth and serious damage to the already stretched American safety net. The last time Congress pulled this stunt, in the Clinton era 17 years ago, all non-essential federal services were cut off for 28 days. This time, Moody's estimates a two-week shutdown would pare GDP by 0.3 percentage points. But if it lasts as long as a month, it could lop off 1.4 points. Putting the damage in dollar terms, Goldman Sachs reckons the standoff could suck $8-billion (U.S.) a week out of the economy.

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This has triggered so much hand-wringing, it ought to be a boon to makers of skin lotion.

Then we have the crisis in Italy, where Mr. Berlusconi has a deep personal interest in triggering new elections as quickly as possible. He faces a multiyear ban on holding public office as a result of a conviction for tax fraud that could see him on the political sidelines as early as next month.

But surely, investors are used to unstable Italian governments by now. Indeed, there is plenty of evidence that the Italian economy tends to work better when the politicians are too busy quarrelling to muck it up. And for that matter, a U.S. government shutdown is not without certain market-appealing positives.

For instance, it means we can all stop worrying about when the Federal Reserve starts tapering. There will be no talk of winding down monetary stimulus as long as the economy has this new dark cloud hanging over it.

Public anger over a cynically engineered government shutdown – including a cutoff of all non-essential services, lost wages and unpaid furloughs for hundreds of thousands of federal employees – may not prevent the same sort of brinksmanship in mid-October when Congress will be required to raise the debt ceiling so Washington can meet all of its financial obligations, including interest owed on government bonds. But the obstructionist wing of the Republican party may not have the political capital to force such a disastrous outcome – at least, that appears to be Wall Street's view.

Failure to provide the U.S. Treasury with that authority would force huge spending cuts estimated to be as much as 4 per cent of GDP and heighten the risk of at least a temporary debt default, which would have far-reaching market consequences. The last fight over the debt ceiling, in July, 2011, ended with an 11th-hour deal, after triggering hefty losses in the bond and equity markets. Only the diehard Tea Partiers are eager for a repeat showing of that movie.

Indeed, if a shutdown is short-lived or nipped in the bud, and the markets shrug off this second, arguably less credible threat of default, it sets up the U.S. for stronger economic growth with less fiscal drag. "[M]uch lower fiscal headwinds in 2014 could help the U.S. to achieve growth next year of a little under 3 per cent, compared with what looks like it will be a little under 2 per cent this year," ING says in a note.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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