How budget showdowns could squeeze the US economy

WASHINGTON - Just as the US economy is struggling to expand at a healthy pace, a pair of political standoffs threatens to slow growth and spook investors.

Unless Congress acts before Tuesday to fund federal spending, some of the government would shut down. Separately, the government will run out of money to pay its bills by late October unless Congress raises the federal borrowing cap. A 2011 fight over the borrowing cap rattled consumers, businesses and investors and likely slowed growth.

Here are questions and answers about how the two standoffs, now intertwined, could affect the economy and financial markets:

Q. What exactly will happen within the next days and weeks?

A. The most urgent deadline is for Congress and the White House to agree to keep funding the government after the current budget year ends Monday. Otherwise, some of the government would have to shut down. The House and Senate are considering bills to fund the government past the deadline. But House Republicans want to cut off funding for President Barack Obama's health care law as a condition of passing the spending measure. Senate Democrats and the White House have balked. Unless one side essentially blinks, a partial shutdown of the government will occur.

Q. What would be the effect on the economy if the two sides miss the deadline for passing the spending measure?

A. About one-third of the government will shut down. About 800,000 of about 2.1 million federal employees will be sent home without pay. National parks will close. Passports and visas won't be issued. The Environmental Protection Agency, NASA and other agencies will close.

The military and other agencies involving safety and security would continue to function. These include air traffic controllers, border patrol and law enforcement officers. Social Security, Medicare and veterans' benefits payments would continue, too. New applicants might not be approved, though.

A partial shutdown that lasts no more than a few days wouldn't likely nick the economy much. But if the shutdown were to persist for two weeks or more, the economy would likely begin to slow, economists say.

Extended closures of national parks would hurt hotels, restaurants and other tourism-related businesses. Delays in processing visas for overseas visitors could interrupt trade. And the one-third of the federal workforce that lost pay would cut back on spending, thereby slowing growth.

A three-week shutdown would slow the economy's annual growth rate in the October-December quarter by up to 0.9 percentage point, Goldman Sachs estimates. If so, the growth rate next quarter would be a scant 1.6 percent, compared with the 2.5 percent that many economists now forecast.

Q. What about the federal borrowing cap? First of all, what is it?

A. It's a legal limit on how much debt the government can pile up. The government accumulates debt two ways: It borrows money from investors by issuing Treasurys. And it borrows from itself, mostly from Social Security revenue.

Q. What if Congress can't agree to raise the cap in time?

A. It could be disastrous. No longer authorized to borrow, the government would have to pay its bills only out of the revenue it gets from taxes and fees. This would force the government to immediately slash spending by 32 percent, the Bipartisan Policy Center estimates. Most analysts think the government would delay paying each day's bills until it had accumulated enough money to pay them all.

Even worse, the government could miss interest payments on Treasurys, triggering a first-ever default by the US government. US Treasurys are held by banks, governments and individuals worldwide. Ultimately, a prolonged default could lead to a global financial crisis.

At the same time, Social Security and other benefit payments would be delayed. Government contractors might not be paid and would likely lay off workers. Paychecks for military personnel could be delayed.

The government actually reached its borrowing limit back in May. Since then, the Treasury has taken a variety of measures to avoid exceeding it. But the cash generated by those measures will run out sometime between Oct. 22 and Oct. 31, the nonpartisan Congressional Budget Office estimates.

The date isn't exact because it isn't possible to foresee precisely how much revenue the government will receive and when.

Q. Will the economy escape harm if both deadlines are met?

A. Probably. But even brinksmanship can have consequences. The last major fight over the borrowing cap, in the summer of 2011, wasn't resolved until hours before the deadline. Even though the deadline was met, Standard & Poor's issued the first-ever downgrade of long-term US credit. That, in turn, led to a 635-point plunge in the Dow Jones industrial average the next day.

In August that year, consumer confidence plummeted to its lowest level since April 2009, when the economy was in recession. Spending at retail stores weakened.

"The fallout nearly caused the fragile economic recovery to stall," says Mark Zandi, chief economist at Moody's Analytics.

The International Monetary Fund estimated last month that US budget disputes, like the 2011 showdown, can slow annual growth by up to 0.5 percentage point in other parts of the world.

The Government Accountability Office later estimated that just the threat of default escalated the government's borrowing costs that year by $1.3 billion, or about 0.5 percent.

The drawn-out fights can cause Americans to delay major purchases, such as for cars or appliances, says Ethan Harris, global economist at Bank of America Merrill Lynch. And they can erode confidence in the United States as a place to do business. Employers become less willing to expand and hire.

On Friday, the US Chamber of Commerce, the National Association of Manufacturers and several other business groups urged Congress to fund the government and raise the borrowing limit.

"It is not in the best interest of the employers, employees or the American people to risk a government shutdown that will be economically disruptive and create even more uncertainties for the US economy," the groups said.

Q. All this sounds pretty scary. Why aren't financial markets panicking?

A. Stock prices have fallen in six of the past seven days, partly because of the looming deadlines. But the price declines have been modest. Many investors likely feel they have seen this movie before and know how it ends: with another last-minute deal.

"After several rounds of fiscal brinksmanship ... markets may be somewhat desensitized to the headlines," Alec Phillips, an economist at Goldman Sachs, wrote in a note to clients.

And much has changed since August 2011. The economy has proved more resilient. Growth has remained modest but steady despite tax increases and government spending cuts that kicked in this year. Despite widespread fears, the downgrade of long-term US credit in 2011 didn't cause investors to sell US Treasurys and drive up interest rates and borrowing costs. Rates remained historically low.

The global economy is also in better shape now. Europe emerged from recession in the April-June quarter. Many investors may be poised to scoop up bargains if financial markets fall in response to Washington's budgetary standoffs.

Previously, "those investors who've kept their cool have been rewarded," says David Kelly, chief global strategist at JPMorgan Funds.