Inflation Remains On The Job

The US economy is taking a multi-billion dollar hit from the federal government shutdown, roiling markets and stoking investor uncertainty.

Meanwhile, many government services are grinding to a halt. An estimated 1 million federal workers are subject to unpaid furloughs, national parks are closed, the National Institutes of Health aren’t accepting new patients and the Census Bureau is virtually shutdown, disrupting the flow of economic data.

My home state of Virginia, which is entering peak fall foliage season, is losing millions of dollars of revenue each day due to the closure of federally owned and operated tourist attractions such as Skyline Drive, which runs through Shenandoah National Park. Each year thousands of tourists drive the 105-mile road to admire the emerging fall colors and hundreds of businesses depend on that flow of traffic—and dollars—to keep their doors open into the next year.

Despite those hardships and the fact that Congressional Republicans are coloring this battle as one of fiscal responsibility, more than half of the money our government normally spends is still being spent.

About 57 percent of federal expenditures are classified as “mandatory spending,” which isn’t subject to specific Congressional authorization. That includes items such as Medicare, veterans’ hospitals, Social Security and other federal retiree benefits. That creates an interesting dichotomy of federal retirees still receiving benefits, even as many of their children who still work for the government are being forced to forego paychecks or, if they’re essential workers, to continue working without pay.

Members of Congress are still getting paychecks, since their pay is covered under a permanent law. And the main instigator of inflation—the US Federal Reserve—remains essentially untouched by the shutdown.

The Fed describes itself! as “independent within the government,” meaning that while it is technically a government agency, neither the President nor Congress must approve any of its policy decisions. It is also funded through interest it collects on the government securities it trades and through fees for services provided to banks such as fund transfers and check clearing, so it isn’t subject to any Congressional spending authorizations.

Consequently, the central bank’s program of purchasing $85 billion worth of government bonds and mortgage-backed securities each month is likely to continue unabated for the duration of the shutdown.

From a valuation perspective, that’s probably not a bad thing. While the S&P 500 has sold off to the tune of about 3 percent since it became clear the government was heading into a shutdown, it could have been much worse.

In 1995 – 1996, the federal government experienced two successive shutdowns as then-President Clinton and Congress sparred over the budget: November 13, 1995 – November 19, 1995 and December 15, 1995 – January 6, 1996. Over that two-month period, the S&P 500 actually gained 6.4 percent, as the market anticipated an eventual compromise.

This time around, though, not only do the parties seem more intractable, the government faces a looming deadline of October 17th to raise the federal debt ceiling or incur a possible default. If you’ll recall, the last time Congress and the President did this dance in 2011, Standard & Poor’s downgraded the country’s sovereign credit rating from AAA to AA+. The market clearly isn’t as optimistic this time around and I would wager the recent decline in the S&P 500 could have been much more severe were it not for the existing Fed support.

It would be a bit surreal, though, if the debt ceiling is reached but the Fed continues its easing program.

Barring an increase, the Treasury Department will be forced to rely on current ! cash flow! s to pay old and existing bills. As a result, Social Security benefit payments could be delayed and some creditors would simply have to wait their turn to be paid. Yet the Fed can continue blowing up an inflationary bubble, all in the name of providing critical economic support, even as the US struggles to pay its creditors.

The government may be largely dormant, but inflation remains on the job.

The odds are someone will blink in this game of political chicken over the nation’s finances. But this increasingly bizarre politic situation, driven by bitterly antagonistic political parties, is precisely why it is so critically important that you take steps to hedge your portfolio against the coming inflation.

Governing the country has become more about scoring political points, rather than looking out for the best interests of the public. That’s why you can continue to count on us to look out for you.