The impact on the markets has made current weakness worse than it might have been due to the liquidity impact of less federal spending.

The purpose of this article is to show that the federal government shutdown is not based on functional accounting but rather on the law. Nothing is stopping the federal government from paying its bills, it does so by crediting bank accounts in the private sector.

The federal government is currently under a partial shutdown.

The core truth of the matter is that a sovereign nation, such as the USA, with its sovereign currency and a freely floating exchange rate, can never go bankrupt on debts denominated in its unit of account for which it is the issuer.

Alan Greenspan: A government cannot become insolvent with respect to obligations in its own currency. (Source: Federal Reserve Board)

The shutdown is based on the myth that the federal government is going to run out of money to pay its bills if it is not allowed to issue more Treasury bonds to match its deficit spending.

The facts are:

The federal government, unlike state and local governments, and unlike you and me, is monetarily sovereign. It is sovereign over its sovereign currency, the U.S. dollar. Being monetarily sovereign, the U.S. government created from thin air all the laws concerning the creation, the destruction and the value of the dollar. It can modify and enforce those laws in any way it wishes. The dollar is 100% a product of laws controlled 100% by the Federal government. State money is created when it is keyboarded into existence when the federal government pays a bill authorized for payment by a Congressional Budget. The federal government has the unlimited ability to create laws from thin air; these laws give the government the unlimited ability to create unlimited dollars from thin air. Thus, our monetarily sovereign U.S. government can never unintentionally run short of dollars. Matching deficit spending with treasury issuance is a voluntary budget constraint, not a real functional accounting constraint. Having the unlimited ability to create dollars, the federal government does not need taxes, and indeed, federal taxed for revenue are obsolete. Once received, tax dollars cease to be part of any money-supply measure - not M1, not M2, not M3. The federal "debt" is unlike all other forms of debt. The federal debt is the total of deposits into Treasury security accounts, which are similar to bank savings accounts. These deposits are paid off upon maturity by transferring the dollars that exist in those accounts back to the checking accounts of the account holders. Finally, being sovereign over the U.S. dollar, the federal government has the unlimited ability to set the value of the dollar at any level it wishes. This means it has the unlimited ability to set inflation at any value it wishes. It is the currency monopolist.

There is legislation requiring Congress MATCH deficit spending with treasury bond issuance. Functionally there is no link, no need to do it; it is a voluntary budget constraint as is the debt ceiling.

When the above voluntary limits are met or exceeded, "sequestration" occurs whereby Federal agencies have their funding automatically cut. This is written in the United States Code ([USC])

Sequestration” involves “the cancellation of budgetary resources provided by discretionary appropriations or direct spending law”.12 The net deficit increase includes estimates of mandatory spending and receipts legislation under §902 and any estimated savings resulting from the prior year’s sequestration. But such an increase does not include the full funding of the deposit insurance guarantee commitment or any “emergency provisions”. The net deficit increase, calculated on a rolling basis and identified on the final sequestration report or PAYGO scorecard of the Office of Management and Budget (“OMB”) under §904 F), is eliminated by reducing all nonexempt mandatory spending accounts by a uniform percentage.

(Source: Harvard Law School Federal Budget Policy Seminar Briefing Paper No. 2)

The same piece of legislation has the following clause that allows sequestration to be relaxed. If the federal government really had no money then no amount of rule relaxation would make a difference. Because the federal government is the issuer of the unit of account [the dollar], it can create as many as it needs in the same way that a referee at a football game can create points for scoring goals, and also take them away for penalties.

Upon the enactment of a declaration of war or a joint resolution (issued in the event of a low-growth report)… (1) the subsequent issuance of any sequestration report or any sequestration order is precluded.” 2 USCS §907. A “low-growth” report is a report issued by the CBO to Congress indicating that “(1) during the period consisting of the quarter during which such notification is given, the quarter preceding such notification, and the 4 quarters following such notification, CBO or OMB as determined the real economic growth is projected or estimated to be less than zero with respect to each of any 2 consecutive quarters within such period; or (2) the most recent of the Department of Commerce’s advance preliminary or final reports of actual real economic growth indicate that the rate of real economic growth for each of the most recently reported quarter and the immediately preceding quarter is less than one percent.” 2 USCS §904(I) (2005). When issuing any reports associated with this section, the OMB shall use the same economic and technical assumptions used in the most recent budget submitted by the President.

(Source: Harvard Law School Federal Budget Policy Seminar Briefing Paper No. 2)

So in times of war or economic growth below zero, the federal government does have money, is not bankrupt, and can pay all its bills and does not need sequestration.

Conclusion, Recommendation and Summary

The currency issuer is only limited by the number of real resources to buy beyond which there is an inflation barrier. No other barrier exists apart from voluntarily imposed ones.

A "government shutdown" is happening right now and so far federal government outlays are much lower than they would typically be and have been since well down even before the shutdown began. The treasury is hoarding cash to meet its statutory requirements to match expenditure with receipt of federal taxes and the sale of treasury bonds. The national accounts make the shutdown look planned.

Normally, there is a cash flow of $60B per month from the federal government into the economy. At present, outlays have been very small.

The above treasury statement shows that outlays have only been about $32B for the financial year so far and most of that came in the last week. The financial year started in October 2018 and expenditures would normally be around 3 x $60B = $180B. This lack of liquidity is a key reason why the stock market is falling at the moment.

The good news is that after the shutdown is resolved there will be a boost of spending as the federal government catches up on its budget and this burst of funds will cause a general rise in asset prices and incomes, and is an investment opportunity that one can wait and plan for.

This is a good time for an investor to be patient and wait for the shutdown to be resolved before taking advantage of the bargain stock prices on offer at the moment. One can expect the broad indexes such as the S&P 500 (SPY) Dow (DIA) and NASDAQ (QQQ) to rise again if only as a counter-rally to the present market retrace.

Even the longest shut-down on record so far only lasted less than two months, and I discuss the impact of that in this article.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long USD, Long Oil, Long Bonds.