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September
27
2023

Toward the Brink
 Jim Rickards

Should market participants be concerned about the possible government shutdown at midnight on Sept. 30?

It’s too soon to answer that question definitively, but it’s not too soon for investors to take some defensive action.

If it does happen, it’ll be different from those that have gone before. Let’s break it all down…

While most of us keep our books and records on a Dec. 31 fiscal year, the U.S. government is different. The U.S. fiscal year runs from Oct. 1 until midnight on Sept. 30.

The fiscal year is dated by the calendar year in which the last day falls.

So the fiscal year beginning on Oct. 1, 2023, is called “Fiscal Year 2024” by the Government Accounting Office (GAO) and the Office of Management and Budget (OMB). Leave it to the government to make things difficult and hard to follow, but that’s how they do it.

That means fiscal year 2023 ends at midnight on Sept. 30, 2023. We’re up against the clock and that’s why you’re hearing so much about a government shutdown right now.

It’s the job of Congress to pass appropriations bills to keep the government open. Under so-called regular order, each major department has its own appropriations bill. So there should be separate bills for Defense, the State Department, the Department of Education and so on.

Each bill should be voted on separately and each bill should pass before Sept. 30 to keep that department and the government as a whole running in the new fiscal year.

But in the real world, the “regular order” process never happens. Typically, the House and Senate and the two parties in each body can’t agree on anything by Sept. 30.

Instead, they pass a continuing resolution (CR) that basically says “everybody can keep spending the same amount of money on the same programs as they did last year and we’ll get back to you on what the new fiscal year appropriations will be.”

A CR can last for various amounts of time from, say, 30 days to six months. Sometimes the CR purposely pushes the deadline past the calendar year-end so Congress does not have to make difficult decisions prior to Election Day in November or the holiday season.

Passing a CR is basically a matter of kicking the deadline into the high grass.

Eventually Congress agrees on spending, but they don’t do it department by department as in regular order. Instead, they sweep the entire $1.6 trillion budget into a single bill called an “Omnibus Bill” that forces members to vote the entire package up or down.

This is a way to force items that many members don’t like (such as abortion spending) into the same bill with things they do like (such as military spending). If you want the goodies, you have to vote for things you may oppose.

That’s how the leadership corrals all the votes they need despite the lack of consensus on many line items.

How did we get here? And why would a potential shutdown just days from now be worse than previous shutdowns?

Read on.

This Time Might Be Different

The U.S. has had 22 gaps in funding the federal budget since the enactment of the current budget and appropriations legislation in 1976. (A gap in funding arises when the new fiscal year has begun but the Congress has not passed any appropriations bills.) Prior to 1980, these gaps in funding did not result in government shutdowns.

But in 1980, Jimmy Carter’s Attorney General Benjamin Civiletti issued a legal opinion that required the government to shut down if a funding gap occurred. This opinion was not adhered to during the Reagan administration (1981–1989) but beginning in 1990, all funding gaps have resulted in shutdowns.

There have been 10 government shutdowns since 1980. The shutdowns in 1980, 1981, 1984 and 1986 each lasted only one day. A shutdown in 1990 lasted three days, another in 1995 lasted five days and a more recent shutdown in 2018 lasted only three days. None of the seven shutdowns just listed was of any great economic significance despite the usual political histrionics.

That leaves three major shutdowns that lasted longer and were more disruptive. The first of these was over year-end 1995–1996 during the Clinton administration when the government was shut down for 21 days.

This was mainly about Newt Gingrich and the Republicans trying to cut government spending at the same time that Clinton was trying to increase spending to help his 1996 reelection campaign. Republicans lost that fight.

The next major shutdown was in 2013 when the government was closed for 16 days. This fight was mainly about Republicans trying to delay funding for Obamacare to allow time to make amendments. In the end, a compromise was worked out, but Obamacare never was repealed or materially amended. Republicans lost this fight also.

The most recent major shutdown was over year-end 2018–2019 during the Trump administration. This shutdown lasted 35 days, by far the longest on record. This was mainly a battle between Donald Trump and Nancy Pelosi about funding for Trump’s border wall.

In the end, Pelosi won and the funding for the wall was never provided by Congress. (Trump later redirected some Pentagon funding to the wall on national security grounds, but only 250 miles out of 1,800 miles needed were ever built.) This was another Republican failure.

If you’re keeping score, it’s Democrats 3, Republicans 0 when it comes to policy fights that lead to major government shutdowns. The Democrats understand this dynamic well and have the media on their side.

By the way, there’s much less to these government shutdowns than the screaming headlines suggest. Critical areas of the government such as national security, defense, energy and operations at the White House continue as if nothing happened.

The Democrats love to close the national parks because they know it aggravates voters (who blame Republicans) but that’s hardly a critical function. Non-essential workers are asked to stay home but when the budget issues are resolved they always get back pay. So the whole thing amounts to a paid vacation for those furloughed and business as usual for everyone else.

With this history of Democrats prevailing on the policy fights and Republicans taking the blame for the shutdown itself, why are Republicans in the House potentially forcing another shutdown this week?

It’s clear that Democrats in the House and both parties in the Senate would sign on for a CR that would push the budget deadline out at least 90 days or even into early 2024. Speaker of the House Republican Kevin McCarthy is working with a razor-thin majority.

Republicans only have a nine-vote majority in the House. That means they can only lose four votes if they want to pass legislation.

McCarthy is facing a rebellion from about 10–15 of the most conservative members of his caucus. Some of them want separate appropriations bills (that’s not happening). Some of them refuse to vote on any CR ever; they want to hit the Sept. 30 deadline. That’s not happening either.

Others are more flexible on timing, but want some conditions on a CR that would impose specific spending caps when the Congress does finally get around to passing individual appropriations.

McCarthy has proposed a 30-day CR with some prospective spending caps. This would never be agreed to by the Senate, but at least it would move the process out of the House and put the ball in the Senate’s court.

More importantly, it satisfies most of the conservative House members who are putting up a fight about total spending and specific programs. They still want separate votes on separate bills, but they’re willing to wait 30 days to try to work things out.

McCarthy’s problem is that there are still six members who won’t agree to this 30-day compromise. Not all of the six have the same wish list. There are two or three who are “Never CR” people.

McCarthy can afford to lose them because he has a four-vote cushion. But there are a few more who want tighter promises on the spending caps. That’s enough to sink the entire process and that’s exactly what’s happening.

Over the course of Sept. 20 and 21, McCarthy lost two key procedural votes on the rules that must occur before the substantive vote on the 30-day CR. McCarthy finally gave up, sent everyone home and will pick up the process this week with just days to go before the Sept. 30 deadline.

Meanwhile, the Senate is trying to rush through its own CR to get ahead of the House. If they can do it, they’ll be able to blame the House for the overall failure if there is one. Most of the Republican leadership in the Senate are in the RINO category (McConnell, Thune, Ernst, Romney, Cornyn, etc.) so they don’t mind blaming the House conservatives one bit.

It’s possible this is just a game of chicken and that the CR will pass in some form late on Sept. 30. My view is that’s unlikely. The divisions are not only between House and Senate, and Democrats and Republicans. There are serious divides within the Republican House caucus between budget radicals and moderate get-along types.

This shutdown is different because it’s not about a specific policy issue such as Obamacare or the wall. It’s about the way the entire government finances itself and ways to cut spending to restore some fiscal sanity to Washington. Those are the biggest budget issues since the current budget process was enacted in 1976.

The radicals are dug in. The RINOS are circling. The Democrats are cheering the shutdown on because they believe it only hurts Republicans. If this shutdown occurs, it could last longer than the 35-day standoff between Trump and Pelosi in 2018. That could do serious damage to an economy that’s already on the edge of recession.

Investors should hope for the best but prepare for the worst. That means reducing equity exposure now and increasing cash allocations until some clarity is restored. That may take the month of October. It may take even longer

James G. Rickards is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. His clients include institutional investors and government directorates. His work is regularly featured in the Financial Times, Evening Standard, New York Times, The Telegraph, and Washington Post, and he is frequently a guest on BBC, RTE Irish National Radio, CNN, NPR, CSPAN, CNBC, Bloomberg, Fox, and The Wall Street Journal. He has contributed as an advisor on capital markets to the U.S. intelligence community, and at the Office of the Secretary of Defense in the Pentagon. Rickards is the author of The New Case for Gold (April 2016), and three New York Times best sellers, The Death of Money (2014), Currency Wars (2011), The Road to Ruin (2016) from Penguin Random House.

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