Our seemingly inept House of Representatives has finally elected a new Speaker of the House. So what? What does this mean as we still face a government shutdown, running a continual budget deficit, still apparently in an inflationary economy and looking as though the US will participate in, potentially, a broader war in Israel? What can we expect for our business as it relates to all this chaos? Let’s discuss each of these elements and how it may have a positive or negative impact on commercial real estate investments.

Impact of a Government Shutdown

A government shutdown can have several effects, varying in severity and scope depending on the length of the shutdown, which parts of the government are affected, and how the government and the public respond. First, below describes some of the potential impacts of a government shutdown:

Economic Impact:

  • The Direct Impact: Federal employees can face furloughs, meaning they are temporarily laid off. While in some cases they may later receive back pay, during the shutdown, they lose income, which can hurt their finances.
  • Macroeconomic Impact: A prolonged shutdown can weaken the overall economy. Consumer and business confidence may decline, and economic growth can slow.
  • Non-essential services may be halted. This can include processing of certain permits, passport services, and more.
  • Although “essential” functions, like national defense and air traffic control, continue during a shutdown, there can be reductions in other areas that indirectly affect health and safety.
  • Delays can lead to backlogs in work that take time to clear even after the government reopens.
  • A prolonged shutdown can affect the U.S.’s global reputation and could impact diplomatic and military operations abroad.
  • It may lead to concerns about the U.S.’s financial stability and its commitment to international agreements and obligations.
  • It goes without saying that there will be decreased public confidence in government and political leaders; again, perceived as a failure of elected officials to fulfill their basic duties.
  • Parties and politicians continue to blame each other for the impasse, thereby influencing upcoming elections or other legislative efforts.

The Reality of the Cost:

  • Ironically, shutting down the government doesn’t necessarily save money. Due to the costs of stopping and restarting programs, furloughing employees, and other factors, government shutdowns can end up costing more than if the government had remained open. So why even dwell on this? Get it done!

Our Government Continually Operating with a Budget Deficit

The United States government continues to run on a deficit for several reasons, many of which have persisted for decades. It’s important to note that government deficits are not unique to the United States; many countries around the world run budget deficits. Here are some key reasons why the U.S. government has a budget deficit:

  • Economic Cycles: The U.S. economy goes through economic cycles of expansion and contraction. Typically, it’s during economic downturns (such as recessions) when government revenues tend to decrease because of lower tax collections, while government spending often increases to support economic recovery efforts, social safety nets, and unemployment benefits. Increase in taxes coming? Income tax? Eliminating of capital gains benefits?
  • Entitlement Programs: The United States has several large entitlement programs, such as Social Security and Medicare, which provide benefits to eligible citizens. While it seems reasonable to allow for these benefits in our lifetimes, these programs have a significant impact on government spending and are expected to grow as the population ages. The cost of these programs often exceeds the revenue generated through payroll taxes, contributing to deficits. Increase in payroll taxes coming?
  • Defense Spending: The U.S. maintains the largest defense budget on the planet and is one of the largest components of federal spending. National security concerns, military commitments, and ongoing conflicts can lead to sustained high levels of defense spending. Folks, get ready!
  • Tax Policy: The tax code in the United States is complex, and various deductions, credits, and loopholes can reduce the amount of revenue collected by the government. Tax cuts, especially for high-income individuals and corporations, can also reduce government revenue, leading to deficits. See above.
  • Interest on the National Debt: The U.S. government has a significant amount of outstanding debt, and it must pay interest on this debt. As the debt grows, the interest payments can become a substantial part of the federal budget, further contributing to deficits.
  • Economic Growth: Economic growth plays a crucial role in deficit reduction. When the economy grows, tax revenues tend to increase, and some government expenditures, such as unemployment benefits, may decrease. So, hey Jerome, whaddya say we pump the breaks on those interest rate increases?!

Historically, running such a deficit should serve to stimulate economic growth during recessions or to invest in long-term infrastructure and development. However, maintaining large and unsustainable deficits over an extended period can have negative economic consequences, such as higher interest costs and inflation, which need to be carefully managed. Do we really need to be worried about an increase in taxes and potentially facing the reality of not having social security and Medicare in our future? Where else can we balance this out?

Let’s Talk about WAR. Yes, WAR.

As we are looking to spend $14+ Billion or more, initially, to support Israel and provide military aid to the Palestinian people. War could potentially have a significant impact on both inflation and interest rates. These effects can vary depending on the scale, duration, and nature of the conflict, as well as the responses of governments and central banks. Here’s a general overview of how war can affect inflation and interest rates:

Inflation:

  • Cost-Push Inflation: Wars often lead to disruptions in the production and supply chains of essential goods and resources, such as oil, minerals, and food. When access to these resources is disrupted, it can lead to higher production costs for businesses. These increased costs are often passed on to consumers in the form of higher prices, leading to cost-push inflation.
  • Demand-Pull Inflation: On the other hand, governments tend to increase their spending during wartime, primarily on defense-related activities. This increased government spending can boost overall demand in the economy, leading to demand-pull inflation if production capacity cannot keep up with the heightened demand.
  • Monetary Policy Response: Central banks may respond to wartime inflation by raising interest rates to curb demand and keep inflation in check. However, the effectiveness of this response depends on the scale of the conflict and the economic circumstances. My estimate is that this move would be unlikely.

Interest Rates:

  • Expansionary Monetary Policy: During wartime, central banks may adopt expansionary monetary policies to support the economy. This can involve lowering interest rates to stimulate borrowing and investment, which can help offset the negative economic impacts of war.
  • Fiscal Policy: Governments often increase their borrowing to finance war-related expenditures. This can put upward pressure on interest rates as the increased demand for borrowing competes for available funds in the credit market. The magnitude of this effect depends on the size of the government’s deficit and its impact on the overall supply and demand for loanable funds. If we go to war, will the government raise our taxes in order to lessen the impact on the deficit and growing national debt?
  • Perceived Risk and Safe Haven Assets: In times of war, investors may perceive higher levels of risk in financial markets. This can lead to a flight to safety, where investors move their capital into assets considered safe havens, such as passive net lease assets or government bonds. This increased demand for safe assets can drive down yields on those bonds (i.e., push their prices up) and lower interest rates.

In summary, both the Federal Reserve and Speaker Johnson are facing a conundrum.

Chairman Powell has voiced that we are still in an inflationary environment:
“Inflation is still too high, and a few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal,” Powell said in a recent speech to the Economics Club of New York. “We cannot yet know how long these lower readings will persist, or where inflation will settle over coming quarters.”

“While the path is likely to be bumpy and take some time, my colleagues and I are united in our commitment to bringing inflation down sustainably to 2 percent,” Powell added.

These comments aside, as we are potentially facing another World War, it is highly likely Powell will need to reconsider this to stimulate the economy during wartime and provide confidence to consumers and employers alike. Unfortunately, achieving the target of 2.0% inflation may have to wait, and simultaneously, we as a country may need to deal with our outsized debt obligations and ongoing deficit issues.

Speaker Johnson is part of a faction that is doing whatever they can to cut spending, reduce the national debt and get closer to a balanced budget. Yet, this same party is planning to support a request for a $14.5 Billion package for support in Israel. Republicans have voiced that approval of this package will be paid for by the reductions in the IRS expansion plan, costing $80 Billion. Whether or not the Democrats play ball with the GOP bill and how this is ultimately negotiated is to be seen. Either way, as we face war and a government shutdown, we may expect Chairman Powell to paused on any further interest rate increases, with the possibility of a drop as we get closer to election time.