The global costs of a U.S. shutdown
April 6th, 2011
02:18 PM ET

The global costs of a U.S. shutdown

A potential government shutdown would exacerbate global doubts about America’s capacity to get its long-term fiscal house in order, according to author Sebastian Mallaby. This would hurt confidence in the U.S. dollar and, over time, could erode America's ability to finance power projection.

Sebastian Mallaby is an economics expert at the Council on Foreign Relations and the author of "More Money Than God: Hedge Funds and the Making of a New Elite."  Here's what he had to say about the dollar, the debt and a potential shutdown:

Amar C. Bakshi: How would a shutdown of the U.S. government potentially affect American foreign policy?

Sebastian Mallaby: I think there are two channels to think about. The first is a reputational one, where allies around the world look at the United States and say, “Gee their political system is so dysfunctional they can’t even keep their government open, so what kind of a reliable ally can they be?”

I don’t want to overstate that because obviously in a government essential personnel including the armed forces are not going to be furloughed and any potential shutdown is probably not going to last very long, but I think there is some additional cost to American reputation – its reliability and competence.

The second channel to think about is the debt market because ultimately American power depends on the American financial capacity to project power. And because of the status of the dollar as a reserve currency and the almost unlimited willingness of investors all over the world to finance American government debt, it has been possible for the U.S., particularly in a crisis when there is a flight to quality in capital markets, to count easy and plentiful funding to support its foreign policies.

So you have the irony that the Chinese and the Russians might vote against, let’s say the Iraq War in the UN Security Council, but then turn around and finance the Iraq War by buying American government debt.

So it really is a matter of enormous importance whether this reflexive unquestioning willingness of foreigners to buy American government debt might be undermined at some point, because at that point American power projection becomes a lot more complicated.

To the extent that people draw a lesson from the government shutdown that the American political system cannot even resolve a fight over thirty billion dollars, how on earth are they going to resolve a fight over a multi-trillion dollar long-term budget deficit?

It probably shakes the market’s confidence in American medium to long-term fiscal responsibility and that makes it harder to persuade investors to buy American debt?

Is confidence already shaken just by talk of a potential government shutdown?

I don’t think you could look at the markets in the last few days and draw any meaningful conclusions about that because there are always other things going on that affect interest rates, but I think it stands to reason that there has already been - especially since the financial crisis when the U.S. budget deficit massively increased - this unstable situation where some of the main purchasers of American government debt, such as the Chinese Central Bank, have been publicly wishing and moaning that the dollar would not be the sole reserve currency in the world.

So the chief buyers of this reserve currency don’t like this reserve currency, and that’s a contradiction that makes the dollar’s future status a matter of some doubt. The way that you could persuade the Chinese to calm down and be relaxed about the dollar as a long term store of value would be if you could say to the Chinese, “Look, Washington knows how to manage its fiscal deficit. They’re going to bring it under control. Don’t worry.” But if you cannot even resolve a relatively small disagreement over the remaining six months of one fiscal year, can you credibly argue that you are going to solve the huge entitlement problem?

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Topics: Economy • Politics • Q&A • United States

soundoff (71 Responses)
  1. Joshua Wertheim

    DLS: I'm sorry but the worst president in the past 63 years was George Bush jr. (extend that – the worst president since Herbert Hoover, and maybe even worse than him). Obama is just doing his best to pickup the pieces of the mess Bush left behind – the housing crisis, the recession/depression, the huge deficit, the banking mess, the Iraq and Afghanistan wars, the distrust that the rest of the world has toward the U.S., Cheney's Halliburton taking the no-bid contracts and moving its headquarters to Dubai, and let's not forget that the political landscape of creepy Conservatism, circle-the-wagons and over-the-top Chauvinism was a direct result of both Bushes too. The cost of healthcare skyrocketed under Bush jr. The quality of our educational system began a downhill dive under Bush Sr. And I say this as a fiscal conservative (social liberal) who absolutely abhors the Republican party as it now stands because it tries to legislate social issues even in the face of the shutdown of our government, which is the most irresponsible behavior I have ever seen.

    April 9, 2011 at 2:02 am |
  2. simplex

    From the other side of the world, I can see that Obama will do the right thing in the situation you are in, whether it will work or not, no one knows, things are hectic all over the world, give him all your support, forget about political parties for now, pull together, we LOVE America with all its faults, and will keep all of you in our prayers !

    April 9, 2011 at 5:28 pm |
  3. jessedziedzic

    Extraordinarily well executed blog post!

    October 20, 2011 at 11:44 am |
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    Thats an all 'round well written blog!!!

    October 24, 2011 at 11:52 pm |
  5. Drip Feed

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    October 29, 2011 at 2:15 am |
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    This could be your greatest post I have read.

    November 14, 2011 at 12:40 am |
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    November 25, 2011 at 3:00 am |
  8. David Ella's Blog

    All round great piece!!!

    December 16, 2011 at 11:31 am |
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