Investors Don’t Fear the Shutdown. Maybe They Should.

(Illustration by Barron’s; Dreamstime (2))

About the author: Christopher Smart is a managing partner of the Arbroath Group, an investment strategy consultancy, and was a senior economic policy advisor in the Obama administration.

Would you lend money to a company whose leaders can’t agree on how best to spend it? Would you buy stock in a firm whose management chooses to suspend operations while they fight over a budget? You may be surprised to learn that you made money over the past week in just such an investment.

In yet another sign of America’s amazing economic resilience, not even the prospect of an extended government shutdown has dented the country’s outlook, as measured by its financial markets. Both the S&P 500 and the Nasdaq Composite have risen since the shutdown started.

But investors shouldn’t be complacent about the latest Washington drama. The cost of the shutdown could be far higher than either side intends or than the market expects. That is because the politicians who have backed themselves into this corner don’t seem to mind inflicting economic damage—so long as they escape blame.

Of course, government operations could spring back to life unexpectedly with a phone call between President Donald Trump and Senate Majority Leader Chuck Schumer. Democrats could consent to some reforms on the health insurance subsidies—the issue at the heart of their holdup—while Republicans could commit to extending that healthcare funding.

But, for now, all signs point to a lengthy period of government worker furloughs, blocked infrastructure spending, and suspended economic data collection. The House has left town, Senate leaders aren’t even pretending to negotiate, and the president seems occupied with ridiculing Democrats on social media.

The impact on the real economy will begin this month when two million federal workers and 1.3 million active-duty military personnel start missing paychecks for their work since Oct. 1. This may sound like temporary inconveniences, since Congress will eventually approve back pay, but consider the economic disruption in the meantime from missed mortgage payments, damaged credit scores, and canceled travel.

The last shutdown, in 2018, lopped just 0.2% off gross domestic product over its five weeks, according to the Congressional Budget Office. Much of that lost economic activity was eventually recovered. That shutdown, however, was only partial; Congress had passed five of 12 appropriations bills to keep parts of the government open.

This time, the risks of a longer and more serious self-inflicted economic wound are far greater. Above all, as hard as it would have been to believe in 2018, partisan rancor has gotten far worse, with both sides hungrier than ever to score political points.

The president’s threats to permanently fire federal workers raise the risk of even deeper damage. Russell Vought, the director of the Office of Management and Budget, has directed all departments to make plans to eliminate positions that aren’t funded and “not consistent with the president’s priorities.” Trump said he may not repay all furloughed workers, which would deepen the economic scars of the shutdown.

Meanwhile, the White House has suspended billions of dollars in infrastructure projects planned for Democratic strongholds, and the Fed will have to make crucial interest-rate decisions without fresh economic data.

Then there is the potential cost of the lost health insurance subsidies at the center of the budget battle. Democrats claim this could add thousands of dollars to family health insurance bills. While the economic impact may not be felt until January, which is when the subsidies are set to expire, the political implications could come as early as next month, when open enrollment for many insurance plans reveal higher rate schedules.

And there is the rub. Democrats and Republicans are focused on the political damage they can inflict on the other party, rather than the potential scars their shutdown leaves behind on the American people. Economic pain can shape political calculus. But that pain is easy for politicians to ignore if they imagine they stand a chance of winning the argument.

As in most wars, the only thing worse than the fighting is surrender—and at this stage, both sides seem to think victory is within reach. The White House believes Democrats are too weak and disorganized; the Democrats believe Trump will have to compromise when 20 million people, concentrated in Republican districts, see their health insurance premiums spike.

Voters have their eye on the ball. A CBS News/YouGov poll released last week shows 49% are “very concerned” about the economic impact of the shutdown. Few think that either parties’ goals make the shutdown “worth it.” Voters blame the shutdown on the president and the GOP only slightly more than on Democrats.

Budgets are about priorities and values, so it isn’t surprising that passing a spending plan is difficult for a political configuration that is so deeply divided on priorities and values. But even an economy clocking 3.8% annualized growth won’t be immune to extended furloughs and spending cuts. Stock prices look vulnerable, too.

Of course, if you are mainly looking for political advantage in the current standoff, there is no better time to avoid the blame for a collapse in economic growth than when all the statisticians have been furloughed.

Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.