How the Shutdown Hammered the U.S. Economy

The statue of Grief and History stands in front of the Capitol Dome in Washington October 15, 2013. REUTERS/Joshua Roberts

How much has the government shutdown and the default threat cost us?

Before the latest congressional melee over government spending, the U.S. federal deficit was shrinking and seemed poised to shrivel even more in the near future. As a percentage of the nation's gross domestic product, the cash shortfall had dropped by half in the past two years, according to Standard & Poor's senior credit analyst Marie Cavanaugh, who heads the ratings team in charge of assessing the U.S. credit rating.

In other words, the United States was on track to slash its deficit and enjoy the spoils of its growing financial recovery - until the shutdown, which has socked the economy in the nose and soured investor confidence everywhere.

"Earlier this year, we raised our outlook for the U.S. from negative to stable based on the ability of Congress to negotiate its way out of the fiscal cliff, the nation's strengthening economic recovery and the fact that the nation's deficit had fallen by half of the 2011 level," Cavanaugh told Newsweek just before Congress cobbled together a last-minute deal.

Now the same ratings agency estimates that the government shutdown knocked $24 billion out of the U.S. economy in just two weeks. That is more than $1.5 billion a day.

Essentially, the fighting over spending leaves America with less to spend.

"The bottom line is the government shutdown hurt the U.S. economy," stated S&P's chief economist Beth Ann Bovino, on the heels of an eleventh-hour budget compromise that effectively delays key fiscal decisions until next year. "In September, we expected 3 percent annualized growth in the fourth quarter, because we thought politicians would have learned from 2011 and taken steps to avoid things like a government shutdown and the possibility of a sovereign default." (In 2011, consumer confidence hit a 31-year low; just this week a Gallup poll similarly showed investor confidence dropping to its lowest level in almost two years. This is probably not a coincidence, as both polls took place during congressional standoffs.)

S&P, which has been the only ratings agency to slash the nation's top-flight credit rating (also in 2011), now expects this year's fourth quarter GDP to straggle in at closer to 2 percent.

Debt Drama
A bourse trader looks at her monitors during the early morning session at the stock exchange in Frankfurt, October 17, 2013. REUTERS/Kai Pfaffenbach

That is, if the U.S. is lucky. With full expectations that consumer confidence will continue to plummet amid the "short turnaround for politicians to negotiate some sort of lasting deal," Bovino predicts, "if people are afraid that the government policy brinkmanship will resurface and, with it, the risk of another shutdown or worse, they'll remain afraid to open up their checkbooks. That points to another humbug holiday season."

Cavanaugh says the agency estimates that for every week the government was shut down, roughly 0.3 percent of the nation's GDP was destroyed. Not really a good thing for a country that, until recently, "was running one of the highest deficits the world has seen since World War II, as a share of the [national] economy," according to Nikola Swann, Cavanaugh's predecessor and the credit analyst who led the team that voted the U.S. credit rating down in 2011.

Swann, who tracked U.S. fiscal health for some time, traces much of the trouble back to 2001, when the September 11 attacks led to a downturn in the nation's economic growth and spiraling spending in the lead-up to the war on terror.

The U.S. did begin to recover by 2007, he says, but then it was buffeted by the financial crisis. By 2009, the nation's cash deficit - the annual gap between spending and revenue as a percentage of its GDP - had swelled to 11 percent, he says. Compare that to a surplus of 3 percent of GDP in 2000. At present, the cash deficit has eased to under 5 percent, Cavanaugh says, but remains at the high end.

"Remember, the Clinton administration benefitted from very high rates of economic growth, real rates that were around 3 percent to 5 percent of GDP," Swann says. "We increased spending but never got back to the high growth rates."

Bovino warns the U.S. still has much to lose if its fiscal game of chicken doesn't end.

As the debt ceiling deadline neared, S&P was minutes away from automatically demoting America's credit rating and tipping it into "selective default." (The only other country to have "SD" status is Grenada.) Fitch, a ratings-agency competitor of S&P, already announced it was putting the U.S. on "credit rating watch negative," citing a lack of "timely" action by Congress to pass a budget.

Like a troubled teenager, America is repeatedly self-harming. "It is simply not a characteristic of the most highly rated sovereigns that you have to worry about them not paying their debts," said John Chambers, global head of S&P's sovereign ratings committee and a member of the team that marked down America's debt rating in 2011, from AAA to AA+. He notes that no nation has ever defaulted for such a ridiculous reason - political games of mutually assured destruction. "It is unheard of in a cohesive civil society, making it all the more puzzling and lamentable that we have these shenanigans over spending that has already been approved by Congress."

When Standard & Poor's, which monitors and ranks the credit of 127 countries, slashed the sovereign debt rating of the United States during the 2011 debt-ceiling war, cries of "unpatriotic" and "anti-American" echoed up Wall Street.

"We knew what we were doing, that it was a historic decision," says Swann. "The volume of calls coming in was more than we could sort through on our own. We were there until late Friday, doing interviews, investor calls, and teleconferences, all through the weekend and the rest of the following week." The hue and cry was no surprise. After all, nothing less than the world's global reserve currency was at stake.

Shutdown Saga
Jason Hardzewicz, a floor official and trader for Barclays, works at his post on the floor of the New York Stock Exchange, Friday, Aug. 30, 2013, in New York. AP Photo/Bebeto Matthews, File

The U.S. rating - alongside that of France, Austria and the Isle of Man - put it behind Sweden, Denmark, Finland, Norway, Germany, the Netherlands, Hong Kong, Singapore, the United Kingdom, and Canada. By losing its gold-star rating, the world's superpower became and remains second best.

"The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective and less predictable than what we previously believed," S&P stated to justify its lone decision in 2011. "The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy."

Now there are three months for Congress to complete its bargaining, pass a budget, and lift the debt ceiling again. If it fails - and everything suggests a return to the impasse we just escaped from - America will be back in default territory. Politicians in Washington will put on the motley, the default circus will resume and the damage to America's economy will start over.

Whatever was said on either side in the latest showdown about reneging on our national debts, defaulting will not be pretty. According to Bovino, if America defaulted it "would be devastating for markets and the economy and worse than the collapse of Lehman Brothers in 2008" and "put the economy in a recession and wipe out much of the economic progress made by the recovery from the Great Recession."