What happens if the US government shuts down?

The US Government has reached its 'debt ceiling' - the self-imposed limit on the amount it can borrow. And unless politicians agree to raise that limit by midnight, there will be a ‘federal government shutdown’ as the government runs out of cash. James McKeigue reports.

Until now, the US government has avoided the austerity measures being driven through by indebted governments in Europe and the UK. Instead, it has focused on spending its way out of trouble.

Yet if Republicans and Democrats can't come to some sort of agreement by midnight tonight (EST) austerity might be forced upon them. The US Government has reached its debt ceiling, a self-imposed limit on the amount it can borrow. Unless politicians agree to raise the limit ie agree to borrow more money there will be a federal government shutdown' as the government runs out of cash.

This isn't the first time something like this has happened. Indeed, it's common for America to reach its debt ceiling. But normally a rise in the ceiling is just rubber-stamped.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Crises like this one only happen when a political stalemate stops the world's biggest debtor from deciding to borrow more money. The last time it happened was in 1995/96, during the Clinton years. Then, as now, a Democrat president found himself battling a Republican-controlled Congress. Republicans say that they will only agree to raise the ceiling if Obama cuts spending in his budget. They appeared to have compromised on $33bn of cuts a tiny fraction of America's $14 trillion overall debt but argument continues over exactly what should be cut.

So if a shutdown happens, what impact will it have? Well the government won't have the money to meet all of its obligations, and so will chose not to pay some of them. The most likely fall guy is the public sector worker. Up to a million 'non-essential' government employees will not be paid. That's around 50% of the federal workforce (which does rather make you wonder why there are so many of them if they aren't essential). When the situation is resolved they will be paid retroactively but Nomura analysts still expect it to cause a "negligible but manageable" drop in GDP of around 0.1% for every week it drags on.

Of course America could also chose to not pay its creditors US government bondholders but so far the ratings agencies seem unconcerned. Fitch said that it was "extremely" unlikely that the crisis would stop America from making "due and full" payments on its debt. Yet lenders are unlikely to completely ignore a shutdown analysts think it could add up to ten basis points (0.1%) onto the ten-year US Treasury yield. That might not seem much until you remember the huge size of US government debt. And of course if yields go up, then the price of existing T-Bills will come down.

In 95/96 the shutdowns did not have a major economic impact although back then America's public debt was only 50% of GDP compared to almost 100% today. The longer of the two shutdowns lasted for 26 days before a public backlash forced a Republican compromise. Today it's less clear if Republicans will be blamed for intransigence, as there is greater public concern about America's rising debt levels. Some observers, including the perennially optimistic rating agencies, hope a crisis might focus politicians on the "fundamental issue of how best to place US public finances on a sustainable path over the medium- to long-term". We won't be holding our breath.

James graduated from Keele University with a BA (Hons) in English literature and history, and has a NCTJ certificate in journalism.


After working as a freelance journalist in various Latin American countries, and a spell at ITV, James wrote for Television Business International and covered the European equity markets for the Forbes.com London bureau. 


James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. 


He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.