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The Dow Jones Industrial Average (DJINDICES:^DJI) is down today as investors fret over the potential government shutdown, but that threat is just a sideshow compared to the debt ceiling issue. Financial chaos will erupt If Congress does not raise the debt ceiling by mid-October and the government experiences a technical default on its debt. As of 1:15 p.m. EDT the index was down 101 points to 15,086, with 28 of 30 DJIA stocks in the red. The S&P 500 (SNPINDEX:^GSPC) was down seven points to 1,683.
While a potential government shutdown set to happen at 12:01 a.m. Tuesday is making headlines, it won't have a visible effect on most Americans' lives unless you live in the Washington, D.C., area, where federal workers are concentrated. Mail will still be delivered, the trains will continue to run, and national-security efforts will not halt.
That said, the length of the shutdown will determine the degree to which it hampers economic growth. According to Macroeconomic Advisers, a shutdown of two weeks would reduce fourth-quarter real GDP growth by 0.3 percentage points. To put that in perspective, second-quarter GDP growth was 2.5%, so a 0.3-percentage point loss is 12% slower growth.
Republicans are trying to use the debate over the fiscal 2014 budget to defund Obamacare. President Barack Obama has said that defunding Obamacare is not negotiable. The worry is that Republicans will say the same of the debt-ceiling debate.
The Treasury Department has said it will not be able to pay all of its bills starting around Oct. 17 unless the debt ceiling is raised. It's worrisome that Congress is waiting until the last minute on the budget debate and hasn't even started talking about raising the ceiling. Since 1939, when Congress stopped having to approve each individual debt issuance, the debt ceiling has been raised 99 times.
Bills Treasury might not be able to pay in a matter of weeks include interest on Treasury bonds, Social Security checks, and Medicare payments. This would have a large negative effect on GDP and would cause mayhem in the world financial markets, as Treasury bonds have traditionally been considered risk-free assets -- safe havens for investors that can be used as collateral in many transactions. Many financial institutions have rules that do not allow them to use securities that are in default for collateral, but the U.S. would be in default if it stops making interest payments. This risks the financial leadership of the U.S. and world economic growth.