Wilted Reputations Left By Shutdown And Default Threat

By John Ydstie

Published October 17, 2013 at 5:54 PM EDT

Traders work on the floor of the New York Stock Exchange on Wednesday, in New York City.

President Obama said Thursday that the government shutdown and threat of default did unnecessary damage to both the U.S. economy and the country's reputation abroad.

Standard & Poor's concluded that the disruption subtracted about $24 billion from the economy and is likely to trim more than half a percentage point off growth in the final three months of the year.

Some of the businesses that lost money during the shutdown will gain it back, as federal workers and the government make up for spending that was deferred. But there are likely to be longer-term repercussions, according to Beth Ann Bovino, S&P's chief U.S. economist.

She says the fact that the agreement only keeps the government funded until mid-January is a worry and leaves hundreds of thousands of federal workers with lots of uncertainty.

"Will you get your paycheck, or will we go back on furlough without pay again? Concerns of a repeat, I am sure, are on people's minds and that's coming in to the holiday season," she says.

Bovino says that could make the most important shopping season of the year pretty ho-hum. And it's not just federal workers who will hold back because of that uncertainty. Other workers will, too, as well as businesses that might decide to put off hiring and investment.

Some of the long-term effects are global, says Adam Posen, who heads the Peterson Institute for International Economics. He says the U.S. suffered reputational damage as, once again, the world watched its chaotic political process produce self-inflicted damage to the economy. Posen says that hurts U.S. leverage in negotiations with other countries.

"If you try to make a deal and it has to go to Congress, the people on the other side will say, 'Why the hell should we adhere to this deal, since Congress is clearly a random mad dog?' " Posen says.

And, he says, U.S. advice in international forums and crises will be discounted.

"They're going to turn around and say, 'Who the hell are you to lecture me, U.S., since you can't even keep your own budget in order?' "

Posen says the credibility of U.S. securities has been eroded in the financial markets as investors decide they're no longer risk-free. That gives the U.S. a lower credit score, and just as a lower credit score means higher interest rates for a household, it will mean higher interest rates for the U.S. government.

That's been obvious in the financial markets in the past couple of weeks, says Jens Nordvig, head of currency strategy at Nomura Securities. He says the interest rate on very short-term U.S. Treasurys went from near zero to almost half a percent — a huge spike — as investors feared they were no longer risk-free.

"That was a very dramatic situation, and the more we have of those examples, the more the risk premium is going to be permanent, the more you'll see a situation where the U.S. government will have to pay higher interest rates than would otherwise be the case," Nordvig says.

And for every tenth of a percentage point increase in interest rates, U.S. borrowing costs rise $2 billion year.

Posen says that as U.S. securities are viewed as less safe, it will erode their elevated status and the position of the U.S. dollar as well.

"This will accelerate the rate at which the Chinese renminbi becomes accepted — at least throughout Asia — as an alternative to the dollar, or Chinese government bonds become accepted as an alternative" to U.S. Treasurys, Posen says.

That could raise the cost of doing business for U.S. firms. And finally, Posen says, chaos is scaring off investment in the U.S.

"Investors, who we need to get the economy out of the sort of slow-growth, high-unemployment state we're in, will feel much more uncertain, and will be less likely to make investments," he says. "And foreigners will be less likely to make investments in the U.S., because you just don't know what the environment's going to be."

Posen says that if Congress repeats its recent performance in mid-January, when government funding runs out again, it will continue to erode confidence in the U.S.