The increasingly dysfunctional politics in the United States might be a threat to the economies of that nation and the world.
Political gridlock and overspending have already triggered embarrassing financial crises in the colony of Puerto Rico and the State of Illinois. Those catastrophes might soon be repeated in other American states; and possibly Washington D.C., and trigger an economic meltdown.
The most embarrassing situation is in the Commonwealth of Puerto Rico; which is legally part of the USA, but not a state. The government of the Caribbean declared bankruptcy in May because it was unable to repay $74 billion (€66.26 billion) in bonds and $49 billion (€43.88 billion) in unfunded pension obligations, The New York Times DealBook reported. The Commonwealth needs bankruptcy protection from creditors’ lawsuits.
A U.S. State cannot Pay its’ Bills
The mess in Puerto Rico is being repeated in Illinois where the state government has not been able to work out a budget in two years. On 17 June 2017, Illinois’s chief financial officer; or comptroller, Susana A. Mendoza told reporters that the state can no longer pay its’ bills.
“My Office has very serious concerns that, in the coming weeks, the State of Illinois will no longer be able to guarantee timely and predictable payments in a number of areas that we have to date managed (albeit with extreme difficulty) despite an unpaid bill backlog in excess of $15 billion (€13.43 billion) and growing rapidly,” a press release from Mendoza reads.
“We are effectively hemorrhaging money as the state’s spending obligations have exceeded receipts by an average of over $600 million (€537.27 million) per month over the past year,” Mendoza noted.
A Threat to the Bond Market
Illinois will not have the money to cover pensions or pay winners of the state lottery if its government cannot come up with more money by 1 July, Fox News reported. The state might be able to borrow money but that will be costly. Illinois’ bond rating has been lowered to nearly junk status by S&P Global Ratings and Moody’s, The Chicago Tribune reported.
There is a danger that Illinois will follow the course of action in Puerto Rico; where the government borrowed far more than it could pay to cover expenses. When the city of Detroit declared bankruptcy in 2013; bondholders received 74¢ on the dollar (0.66 on the euro). This might be a major threat to the bond market; and retired Americans because many of them are heavily invested in government bonds through mutual funds, and retirement accounts. Illinois state bonds had been a popular investment because they paid 5.5% interest, compared to the 2.2% paid by US Treasury bonds.
Municipal bond values might drop dramatically if Illinois declares bankruptcy. The possibility is being raised because a group of healthcare companies have sued the state for $2.3 billion (€2.06 billion). The money is owed by Medicaid Illinois’s health insurance system for the poor – which is no longer paying its’ bills.
Some observers are worried that the situations in Illinois and Puerto Rico might be repeated elsewhere in the United States. Fears have been raised about the state of Connecticut and the city of Philadelphia.
How American Politics Generate Fiscal Crisis
The fiscal crises in the United States are the result of the structure of American governments and a lack of political not a shortage of money. The major cause of the problem is the way the state, commonwealth and federal governments in the United States are organized.
The federal and state constitutions separate powers between the branches of government. The American president is officially the head of the U.S. government; but unlike the UK Prime Minister he lacks the power to write a budget. The budget is written by Congress which has the power to impose taxes and allocate funds. The President can send a document labeled “budget” to Capitol Hill, but it is nothing more than a wish list of desired spending.
This situation can create political gridlock because the President and Congress can be from entirely different parties with divergent political philosophies. That’s what happened in Illinois; where the state legislature is controlled by the left-wing Democrats, while the governor Bruce Rauner is a conservative Republican. Rauner and the legislature were unable to agree upon a budget which led to the fiscal crisis.
Will there be a Fiscal Crisis in Washington?
The situation in Washington is a little better because President Trump and majorities in both houses of Congress are Republicans. Gridlock is still possible because there are vast ideological differences between Trump and Congressional Republicans. Trump is an outspoken advocate of single-payer healthcare and increased spending; while most Congressional Republicans are fiscal conservatives that oppose any government spending on healthcare.
A serious crisis might occur if Democrats win control of Congress in the midterm elections scheduled for November 2018. Some observers think leftwing Democrats have a good chance of unseating enough Republicans win a majority in the lower house of Congress.
The last time America had such a division the federal government shut down because former President Barack Obama (D-Illinois) and Congressional Republicans were unable to agree on a budget. Under the American system the President has to sign the budget for it to go into effect.
Destructive Political Conflict in Washington is Likely
During the last such budget impasse in 2011; Moody’s lowered US treasury bonds’ rating from AAA to AA+ for the first time. Such a scenario is likely if there is a major political conflict between Trump and Congress.
An even more destructive occurrence would be efforts by Democrats; or conservative Republicans, to impeach or remove Trump from office. This catastrophic scenario is plausible because of popular opinion. A Public Policy Poll on May 31, 2017, found that 47% Americans wanted Trump impeached, The Hill reported. Since around 71% of Democratic voters want impeachment according to Politico, it is likely if that party wins control of Congress.
Investors had better pay close attention to the fiscal crises in the United States and the situation in Washington. We are likely to experience some nasty political surprises from Washington; that will disrupt the markets, and affect the value of some investments such as bonds in the next few years.