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Shutdowns, defaults and interest rates

October 04, 2013

| MoneyRates.com Senior Financial Analyst, CFA

One of the dangerous things about the fiscal confrontations taking place in Washington is that depending on where you live and what you do, you might not immediately notice the shutdown of the federal government or the effects of a debt default. However, those actions could ultimately have severe impacts that last well beyond when an agreement is reached to resolve the immediate disputes.

One area likely to be impacted is interest rates. Whether you are a bank depositor wishing savings accounts could get a little ahead of inflation, or a home owner hoping to see attractive refinance rates in the future, Washington's brinksmanship may destroy those aspirations.

Potential effects of the shutdown

From savings accounts to refinance rates, here are some plausible effects of the current federal government curtailment, and of a possible default on U.S. government debt obligations.

  1. The shutdown is a further drag on economic growth. Some 800,000 government employees have been sent home, which is more jobs than the economy created in the last four months combined. In short, this shutdown could stop whatever momentum the economy has dead in its tracks. If this happens, depositors may have to live with near-zero interest on their savings accounts for a while longer. Homeowners may see the value of their properties start heading south again, which could prevent refinancing even if refinance rates are attractive.
  2. A default would shake up lender confidence. One thing that could send interest rates soaring despite a slow economy is if the confrontation in Washington goes to the next step of forcing a default on U.S. debt obligations by not raising the federal debt ceiling. For decades, U.S. Treasuries have been considered the most risk-free long-term investments available, because Uncle Sam was considered the most reliable borrower. If confidence in that borrower is shaken, lenders will demand more interest in the future. Rising U.S. Treasuries yields would force a host of other interest rates to rise along with them. Under this scenario, savings accounts could see higher interest rates, but at the cost of severe economic disruption.
  3. A compromised dollar would lead to inflation. Part of that disruption could be soaring inflation. The U.S. dollar has long been the world's reserve currency of choice, and the trading currency for major commodities, such as oil, around the world. However, if the financial backing of the dollar is called into question, demand for the dollar will suffer. This drop in demand would likely cause the value of the dollar to fall relative to other currencies, causing prices to rise. Inflation hurts borrowers and lenders alike, which is probably a hint to where the fiscal confrontation is heading -- everyone ending up a loser.

Given the amount of tough-guy posturing that has become a part of the budget confrontation, it seems as though some of the players fancy themselves as gunslingers facing off at high noon. The only problem is, this is the kind of unpredictable shoot-out in which innocent people tend to get hurt.

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