Will Financial Markets Crash Before October 17, or After?

October 4 is the first Friday of the month, the day when the Bureau of Labor Statistics routinely reports the jobs numbers for the preceding month.   Is the havoc created by our current political deadlock over fiscal policy showing up as job losses?   We have no way of knowing.  On October 1 the BLS closed for business, like many other “non-essential” parts of the government.  There will be no more employment numbers until the shutdown ends.

Last week, Wall Street economic analysts responded to the usual surveys as to what they thought the upcoming employment numbers would be.   (These surveys are what the media refers to each month when they tell you that employment rose or fell “more than economists expected.”)    The median forecast in last week’s  Bloomberg survey, for example, was a prediction that the BLS would report that “Payrolls increased by 175,000,” the biggest gain in four months.   But there was no word on how many of the respondents recognized that there would in fact probably be no number at all on October 4, because the Labor Department would have been closed by the government shutdown.

It seems to me that this minor blind-spot is symbolic of a failure of Wall Street to focus adequately, until now, on the long-impending government shutdown and still-impending October 17 deadline for raising the national debt ceiling.   One reason for the lack of concern up until this point is that observers are jaded; they feel they have seen this movie before (with fiscal cliffs, sequesters, shutdowns, and ceilings); that it is “only politics;” and that Washington always averts catastrophe at the last minute. Well, maybe not this time.

Another reason is that the financial markets all summer long were busy over-reacting to developments regarding the Federal Reserve.   The stock market reached a high two weeks ago on the information, which was considered news, that monetary policy was not going to be tightened imminently after all.   Now the fixation is passing from monetary policy to fiscal policy. Not a moment too soon.

Both sides in Washington are firmly dug in, and don’t plan to back down.  If the politicians don’t get their act together  and the debt ceiling is really not raised, the results will be very bad indeed.   I actually mean “if the Republicans don’t get their act together.”  I think President Obama is fully credible when he says he will not let one faction in one party in one house of congress, in one branch of the government, threaten to blow us all  up if they don’t get their way on the Affordable Care Act.

The US has never defaulted on its obligations before.  Some continue to imagine that the government could stay within the debt ceiling but meet its obligations out of incoming tax revenue.  This is wrong.  Even if there were enough tax revenue to service the treasury debt for awhile, there would not be anywhere near enough to meet all the other legal obligations that the federal government has already incurred under the congressionally passed budget.  If the government doesn’t pay Staples the money that is owed for office supplies that it bought last month, that is a legal default just as much as if it fails to service its bonds.

Perhaps, given the desperation of the situation when the time comes, President Obama could try one of the gimmicks that have been proposed, such as minting the trillion dollar coin or taking the position that the debt ceiling violates the constitution or other laws.   These are not attractive options because they would probably provoke a constitutional crisis.   So let’s assume that he doesn’t take them.

It seems to me that this then leaves two possible outcomes: either the financial markets fall before October 17 and the Republicans respond by backing down or the financial markets fall after October 17 and the Republicans respond by backing down.   Precedents for financial markets forcing such a reversal include the delayed congressional passage of the unpopular TARP legislation in the fall of 2008 and the delayed passage of an unpopular IMF quota increase 10 years earlier.   (In the last debt ceiling showdown, in August 2011, default was avoided at the last minute;  but the stock market fell sharply anyway, when S&P for the first time ever downgraded US debt from AAA.)

After a remark by Obama about the markets yesterday, some accused him of “scare tactics,” of fanning Wall Street fears for political advantage.  The reality is almost the reverse:  if Obama thinks like a pure politician, he will let the Republican Party complete the process of committing suicide (suicide by means of binge tea partying).  The way to do this would be to wait until October 17 and let the Republicans take the blame not just for a decline in the stock market or for the inconvenience to anyone who has to deal with the government during the shutdown, but - if there is no resolution in time to raise the debt ceiling - to take the blame for the likely result: a second global financial crisis and global recession.

But that would be a very high price to pay for political advantage.  Even if the Republicans cave in within a few days after October 17, so as to avert the global recession, by then the creditworthiness of US Treasury debt will have been irreparably harmed.  My guess is that Obama thinks it would be much better for the country if the markets were to tank and the Republicans to back down before October 17 rather than after, even though the Tea Party would then live to fight another day.

[I discussed these matters this morning on BBC radio, "US Shutdown Risk to Global Economy," and Fox Business News, "Who Will Listen to the President's Warning to Wall Street?" Varney & Co..  One of the Fox team claimed that the stock market has usually gone up in government shutdowns.  It turned out that her statistic referred to the subsequent month;  in other words the market goes up when the shutdown is ended.  In fact it typically goes down during shutdowns, by 2 ½ % in the case of those lasting 10 days or more. It looks to me that this exchange was excluded from the segment posted on the Fox website.].