It’s never a good time for the US economy to be hit by a government shutdown.
But now would be particularly inopportune — and a shutdown is looking likelier by the day.
Not only is the economy having to cope with an interest-rate shock triggered by the country’s poor public finances.
It also must grapple with heightened Middle Eastern uncertainty that is sending international oil prices through the roof.
A government shutdown next month would greatly increase the chances of a recession by early next year.
By raising questions about the political will to address our budget-deficit problem, it would also invite the bond vigilantes to send long-term interest rates even higher than they already are.
Unfortunately, there is a real risk of a government shutdown starting Nov. 18, when the stopgap funding bill former Speaker Kevin McCarthy negotiated with the Biden administration expires.
Lawmakers must pass another spending bill before then to avoid a shutdown. Yet the prospects for that happening appear dim.
After Jim Jordan’s third attempt to become the new speaker failed, the Republican Party is yet to agree on a candidate who might secure enough House votes.
Even if an agreement can be reached, it is far from clear a new speaker could get a spending bill through Congress without suffering the same fate as McCarthy when he compromised with the Democrats.
That prospect could inhibit any new speaker from striking a deal with the Biden administration that might be deemed too soft on public-spending cuts to reign in the ballooning budget deficit.
A government shutdown would cost the economy around 0.2% of gross domestic product a week, according to Goldman Sachs.
So if a shutdown were to last five weeks, as the 2018-2019 shutdown did, a full percentage point could be shaved off GDP.
Once the shutdown ended, GDP would be expected to rebound by the same amount.
In normal times, such a temporary hit would not be a matter of undue concern.
But that is not the same case when the economy is already slowing in response to the fastest pace of interest-rate hikes in decades and suffering from a number of shocks — and our public finances are in such poor shape.
Even before the threat of another federal shutdown, over the past two months long-term Treasury bond yields have spiked to a 16-year high of 5%.
That’s as markets have begun to fret over the fact the country is running a budget deficit of 8% of GDP at a time of cyclical economic strength.
An actual shutdown must be expected to send those yields higher, as it would reinforce investor fears the country’s public finances are on an unsustainable path.
The economy can ill afford a further jump in long-term interest rates.
Mortgage and automobile borrowing costs have already surged to 8% — a huge year-on-year jump for auto loans and a 23-year high for mortgages.
Those rates threaten to crush housing and automobile demand.
The spike in long-term interest rates, meanwhile, has made a large dent in the banks’ balance sheets by reducing the value of their large bond portfolios.
It comes as banks are facing a wave of loan defaults, especially in the troubled commercial real-estate space.
That threatens a renewed crisis in the regional banks, which have around 20% of their balance sheets exposed to real-commercial-property lending.
The threat of a government shutdown looms at the same time the Israel-Hamas conflict is raising market concerns about an oil-supply disruption.
That has caused oil prices to jump toward $100 a barrel.
The consequent likely uptick in headline inflation because of higher prices at the pump will make it difficult for the Federal Reserve to back off from its hawkish monetary-policy stance any time soon.
We have to hope our politicians begin to put country above their narrow political interests and soon find a way to avoid a government shutdown.
If not, brace for an economic recession by early next year.
American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.
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