US debt crisis: Three things to watch

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Over the past week events in the US have provided a lot of fodder for the media and there has been much debate over the likely effects of both the government shutdown and the debt ceiling. So, in light of what is going on in the US, what do manufacturers need to keep an eye on over the next couple of weeks?

Here are three things to keep an eye on:

The 17th October

On 17th October the US is forecast to exceed its current debt ceiling of $14.3 trillion. That leaves just 10 days for the US government to come to an agreement regarding the debt ceiling and budget measures.

What might happen if the debt ceiling is breached?

It is hard to know for sure as the US government has never defaulted on its debt obligations before. But in a recent report on the issue, the US Treasury said the following:

‘A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.'

For the closest historical precedent we need only look to the recent past in 2011 when the US reached a bit of an impasse relating to the debt ceiling. The Treasury's short paper outlines some of the implications of this period, which included falling consumer confidence, general disruption in financial markets, falling equity prices, greater volatility in the stock market, increasing corporate risks spreads and slower job growth.

What about the impact of the government shutdown?

Again, it is hard to know for sure but economists have estimated that a week-long shutdown could shave up to a quarter of a percentage point off growth estimates. But anything more protracted would further weaken the economy.

Consumer and Business confidence

In 2011 both household and business confidence fell as the debate about the debt limit grew. We might expect to see something similar occur over the next couple of weeks, particularly if the debt crisis and government shutdown remain protracted.

The most recent indicators published in early September show consumer confidence weakened but the Manufacturing ISM index strengthened slightly. Perhaps too soon to tell how US events are impacting these indicators so we will come back to this next month. The Gallup daily tracker of economic confidence shows confidence has weakened over the past week.

Too soon to tell how events are impacting confidence indicatorsIndex, ISM 50=neutralSource: ISM, Conference Board

Exchange rates

The effects of all of this on the US exchange rate will be watched by manufacturers, both their impact on the cost of inputs and the price of outputs. Over the past month we have seen the $US weaken somewhat so the question is to what extent might this trend continue of the next couple of weeks?

A default would likely cause the value of the $US to plummet and the implications of this would be considerable, as would falling confidence in the US and the flow on implications for the international economy. The major risk for manufacturers is volatility in the exchange rate, which adds uncertainty and risk to the outlook. In EEF's Executive Survey 2013 over one third of respondents indicated they saw significant movement in exchange rates as a risk to growth in 2013. This was substantially higher than 2012. See this previous blog of ours for more info on how exchange rates affect UK manufacturers.

US effective exchange rate$US, 1990 average = 100Source: Bank of England

The closer we get to the debt ceiling the more worrying things get but given the catastrophic nature of a default it would seem unlikely that this will eventuate. Before the ceiling is reached we expect the government to come up with some solutions, which could include budget changes or raising the debt ceiling. However, the events of the debt ceiling impasse in 2011 shows that even the current stalemate is likely to be generating uncertainty and weakening the economy.

The Economist sums the situation up well - When you are brawling on the edge of a cliff, the big question is not “Who is right?”, but “What the hell are you doing on the edge of a cliff?”

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