Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 33

US Government shut-down – been there, done that

As yet another US budget crisis looms in Washington, the US Government may run out of money and be forced to close down. It will not be the first time the US Federal Government has run out of money, unable to borrow more to keep paying its bills. It has happened before - most recently in 1995 and 1996. Scary as this may sound to investors, the impact on markets of recent government shutdowns was different to what many expected.

1980s boom financed by debt

The deep financial, economic and political crises of the 1970s came to a head in 1979. The US Treasury defaulted three times on its Treasury Bills in 1979, when Congress didn’t legislate in time to raise the debt ceiling – like in early August 2011, and at the end of December 2012, and again this month. But these temporary defaults on US government debt became the dawn of a brand new era of growth and prosperity for Americans. We will look at recent US Treasury defaults next week.

Following Ronald Reagan’s landslide victory over Jimmy Carter in the November 1980 elections, Reagan, Volcker, and Thatcher led the macroeconomic revolution in the 1980s, back toward smaller government, lower tax rates, privatisation of industries and deregulation of markets. These reforms brought lower inflation, lower interest rates, lower unemployment rates, a return to economic growth and prosperity.

Or so it seemed.

The US economy may have grown strongly in the 1980s, 1990s and 2000s after the stagflation of the 1970s, but the boom was financed by a massive build-up of budget deficits, trade deficits and debt.

When Reagan came to office in 1981 the US was the biggest creditor nation – it was the banker to the world. By the end of Reagan’s first term it had become a net debtor nation. By the end of his second term the US had become the world’s biggest net debtor and Japan had become the biggest creditor and main banker to America. This is shown in the following chart of the US net foreign asset position.

Trade deficits increased rapidly under Reagan, were lower under Bush Senior and Clinton, but then blew out to record deficits again under Bush Junior. The trade deficits were financed by foreign investors, including a rapid build-up of foreign debt – firstly owed to the Japanese, and during the 2000s, to the Chinese.

1995/1996 deficit crisis and government shutdown

Fifteen years of spending and borrowing binges that started under Reagan led to the next crisis: the 1995/1996 government shut-downs. The budget stand-off forced temporary shut-downs of non-essential government services for 28 days across two periods: 14 to 19 November 1995, and again from 16 December 1995 to 6 January 1996.

The crisis was a culmination of the stand-off in the 1990s between the Republican controlled Congress (led by Newt Gingrich) and Democrat President Clinton. Clinton’s 1993 Deficit Reduction Act was opposed by Republicans in Congress, who wanted more cuts to welfare, mainly Medicare.

By pushing the President all the way down to the wire in 1995 and forcing a shut-down of the government, Gingrich was seen by the public as going too far in putting political point-scoring ahead of America’s credit standing in the world. Gingrich’s loss of public support effectively ended his political career.

The following chart shows US interest rates and inflation during the 12 months from July 1995 to June 1996.

The Fed reduced the Fed Funds target rate three times from July 1995 and January 1996, following the seven rate hikes between February 1994 (which had triggered the 1994 bond market crisis) and February 1995. Short term rates were drifting down during the second half of 1995 and did not spike upward when the government shut-downs occurred, as might be expected in the event of a cash shortage. Rates stabilised at around 4% during 1996, and the Fed did not cut rates again in that cycle.

Long term bond yields were on the way down following the 1994 rate hikes, but started to rise again from January 1996 following the shut-down crisis. There are several likely reasons for the rises in bond yields. The first is that inflationary expectations were rising – with inflation still running at 3% while the Fed was cutting rates and the economy was also growing relatively strongly.

Second, it is possible that the increase in bond yields also started to factor in a credit default premium since clearly shutting down the government was not a long term solution to the deficit/debt crisis. However a stronger argument is that it reflected higher inflationary expectations as a result of Clinton’s perceived victory over Gingrich in the PR war, meaning there was likely to be less pressure to balance budgets in future and more latitude to keep running expansionary deficits.

The next chart shows the US dollar index (trade weighted basket) and the S&P 500 index over the same period.

The US dollar surged during the Russian bank crisis in August 1995 and then kept strengthening during the budget stand-off and even during the government shutdowns. Far from panicking in the crisis, investors kept buying US dollars and US shares. Over the 12 month period the US dollar gained 10% and the S&P 500 index put on a decidedly bullish 20%.

President Obama and the Republicans in Congress today are keen to not repeat the errors of gamesmanship in the 1995/1996 shut-down crisis. Painful as the shut-downs were at the time for staff and suppliers, markets ignored them and kept on booming. However the crisis did act as shock therapy for the President and Congress and it stunned both sides into constructive dialogue and action.

As a result, a compromise balanced budget bill was passed in August 1997, aimed at balancing the budget by 2002. In fact the goal was achieved earlier than expected, thanks to the booming dot-com economy that delivered better than expected tax revenues and lower than expected welfare costs.

To this day, Republicans and Democrats both claim credit for the 1998-2000 surpluses, and they are both partially correct – it was the bi-partisan co-operation that was forged by the shock therapy of the shut-down crisis that produced the result.

Clinton is the only President since Nixon (Republican) in 1973 to achieve a budget surplus. Not only that, there were three surplus years in a row – 1998, 1999 and 2000 - a feat not seen since the Kennedy/Johnson (Democrat) surpluses of the early-mid 1960s.

To sum up, the government shutdown crisis of 1995 and 1996 was shrugged off by markets and served as shock therapy that forced both parties to the negotiating table to come up with bi-partisan action that resulted in a rapid return to surplus. Bi-partisan action is what is sorely needed in Washington to solve the current crisis, but it has largely disappeared during the Obama administration.

Perhaps a government shutdown or debt default will provide the necessary catalyst once again as it did in the past.

 

Ashley Owen is Joint Chief Executive Officer of Philo Capital Advisers and a director and adviser to Third Link Growth Fund.

 

RELATED ARTICLES

Meg on SMSFs: Winding up market linked pensions with care

Living within one’s means

Epilogue: Death duties, where angels fear to tread

banner

Most viewed in recent weeks

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

Supercharging the ‘4% rule’ to ensure a richer retirement

The creator of the 4% rule for retirement withdrawals, Bill Bengen, has written a new book outlining fresh strategies to outlive your money, including holding fewer stocks in early retirement before increasing allocations.

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are franking credits worth pursuing?

Are franking credits factored into share prices? The data suggests they're probably not, and there are certain types of stocks that offer higher franking credits as well as the prospect for higher returns.

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Latest Updates

A nation of landlords and fund managers

Super and housing dwarf every other asset class in Australia, and they’ve both become too big to fail. Can they continue to grow at current rates, and if so, what are the implications for the economy, work and markets?

Economy

The hidden property empire of Australia’s politicians

With rising home prices and falling affordability, political leaders preach reform. But asset disclosures show many are heavily invested in property - raising doubts about whose interests housing policy really protects.

Retirement

Retiring debt-free may not be the best strategy

Retiring with debt may have advantages. Maintaining a mortgage on the family home can provide a line of credit in retirement for flexibility, extra income, and a DIY reverse mortgage strategy.

Shares

Why the ASX is losing Its best companies

The ASX is shrinking not by accident, but by design. A governance model that rewards detachment over ownership is driving capital into private hands and weakening public markets.

Investment strategies

3 reasons the party in big tech stocks may be over

The AI boom has sparked investor euphoria, but under the surface, US big tech is showing cracks - slowing growth, surging capex, and fading dominance signal it's time to question conventional tech optimism.

Investment strategies

Resilience is the new alpha

Trade is now a strategic weapon, reshaping the investment landscape. In this environment, resilient companies - those capable of absorbing shocks and defending margins - are best positioned to outperform.

Shares

The DNA of long-term compounding machines

The next generation of wealth creation is likely to emerge from founder influenced firms that combine scalable models with long-term alignment. Four signs can alert investors to these companies before the crowds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.