Broker Check

Political Risk Highlighted in 2019

January 18, 2019

It has only been a couple of weeks since the calendar turned over to 2019. Yet a clear theme has already emerged as the key risk that threatens to define the year when it comes to the economic data and the markets: Political risk in the US and abroad. Unfortunately, this risk is almost entirely self-inflicted yet there appears to be little political will to act to mitigate this risk.

In the US the partial government shutdown continues to drone on with no end in sight. True, the majority of the federal government remains funded. In addition, the debt ceiling is unlikely to become an issue until March which reduces the risk that the US government will miss interest payments on the debt or be subject to a credit downgrade. However, the 800,000 federal employees who are missing out on $3 billion dollars in compensation will likely weigh on the economy with the impact increasing as the shutdown continues. Lost income of $3 billion is not enough to directly impact an economy that produces over $20 trillion of goods and services each year, but the indirect impact will increase and compound as time goes on.

Federal employees who miss payday will likely respond by tapping their savings in the short-term. However, they are also likely to cut spending in order to preserve as much of their emergency fund as possible. Given that the money supply in the US is turned over on average 10 times per year, a term called the velocity of money, the loss of $3 billion of wages could impact $30 of economic output for the year. This represents a loss of 0.15% of economic output per missed paycheck. On an annualized basis this could subtract 3.6% from US economic growth which is roughly the total growth rate for all of 2018. In other words, should the shutdown persist forcing federal workers to cut back on spending it could cause the US economy to stagnate in 2019.

Meanwhile, in the UK the Brexit negotiations do not appear to be going well. Attempts to negotiate an orderly exit from the European Union have come to an impasse which may lead to a “no-deal” Brexit. Such an event will likely create major economic disruptions to the UK economy. For example, exports of goods and services represent 30% of UK economic activity. In addition, the UK’s trading partners are also likely to be impacted given that the UK imports 32% of its GDP annually. In other words, a huge amount of economic activity will be negatively impacted by a disorderly Brexit.

Also in Europe, the Italian government is heading for a showdown with European Union officials. The new ruling 5-Star party in Italy is planning to pass a budget that will be loaded with tax cuts and new spending plans despite the nation’s existing high debt levels. The budget represents a rejection of European Union rules which require that countries limit deficits to a small percentage of economic output. Given the political shifts in Italy this could be the first step in a process that may lead to Italian citizens choosing whether to remain in the European Union or attempt a Brexit of their own.

Finally, the trade war with the US appears to be weighing heavily on China’s economic growth. A number of indicators show that the increased trade barriers have hit China harder than the US as China is still highly dependent on international trade for economic growth. Yet to date the Chinese government has been unwilling to compromise on trade.

The question that many economists are asking is: How much economic pain will be needed before global political leaders rethink their current policies? Unfortunately, many politicians may not realize that they are playing a dangerous game in which they may be able to negotiate small concessions at the cost of a global recession. In this case the cost will likely be far greater than any benefits that emerge from the myriad of political standoffs occurring around the globe.