Article by Richard Samuelson forecasting the economic health of the U.S. for 2013 and beyond:
The Most Important Election (2012) in our Lifetime?
Count me among the many who were surprised by the November election results. Not only was I convinced Romney would win, but on the back of that success republicans would likely take control of the Senate and even extend their current majority in the House. None of this happened.
The fact that favorable polls notwithstanding, Republicans lost so many races suggests that the failure was not simply Mr. Romney’s fault. No campaign is perfect but his was certainly adequate to the task of unseating a President with a demonstrably poor economic record. Some maintain that twenty years ago or even less, Romney probably would have won but for our demographically shifting electoral base. I am not so sure. Based on what I observed locally in the state of Washington, it seems that at the margin, democrats coalesced better around a single candidate in the primaries, were less reliant on pure volunteers and more disciplined in gathering votes. That is all it takes in a close election, or in this case, many close elections.
Speculation already abounds as to what the Republican party should do in the wake
of this “disaster.” The answer is surely not to become closet Democrats. In fact, I would argue that the disaster is more temporary than it appears and certainly does not represent an unsalvageable shift in the electorate. In reality, the popular margin of victory was close even if the electoral college victory was lopsided. That said, it is the lopsided electoral college victory that will no doubt be interpreted as a decisive mandate for the Obama agenda. Expect a barrage of policy overreach to follow.
So, now that the most important election of our lifetime (or at least since the contest between Reagan and Carter) has been lost, where will America end up in four years? And what does it mean for Republicans? If there is any consolation here it is: we do not actually know how Mr. Romney would have performed as president, at least in terms of addressing our fundamental problems. He might have been outstanding or much less so for any number of reasons. Being president is a famously difficult job. I voted for him out of a conviction that he possesses the strategic and organizational experience needed to halt and maybe even reverse our continued slide toward economic mediocrity and its consequences.
And this brings me to my first point. The persistent problem with Obama is ideological. He simply does not bring a fundamental understanding or belief in what drives economic prosperity in this or any other country. From the first, his priorities have focused on altering our social contract before reviving our flagging economy reigning in fiscal policy. With the election behind him, why on earth would this change? Indeed, put another way, he has only four years to secure this very legacy. Against that background then, the obvious immediate consequences of his victory are clear:
Obamacare will not be repealed and its implementation will have a negative effect on hiring at the margin as companies cope with increased costs. More borrowing will be required at the margin to fund coverage of some 30 million persons who lack health insurance coverage today. As others have noted, the growing cost of healthcare overall will certainly not be contained in any meaningful way in the absence of more market based price signals. Voters will notice this.
The Dodd Frank legislation will stand and its regulations will gradually be finalized. To be sure, this legislation will not prevent a financial crisis in the future, but at least there is now a better defined procedure for winding down elephant institutions. That said, by concentrating risk through effectively guaranteeing a handful of institutions which are viewed as too big to fail, taxpayers are now explicitly rather than implicitly on the hook when the next crisis comes. Call it a blow for clarity.
Comprehensive immigration reform will be aggressively pursued and there is a strong likelihood that any agreement will involve a partial amnesty. Republicans are already blaming the anti-immigrant rhetoric of certain republican candidates on their poor showing with Hispanic voters. In reality, pandering to an ethnic voter block that is concentrated in a minority of states will never earn them a majority of that ethnic vote. That transition can take generations. But it will most certainly alienate the members of their base that believe in old fashioned notions like “the rule of law.” The tea party might even be tempted to run its own presidential candidate in 2016. Wouldn’t that be exciting.
More interesting is why there is so little uproar over how republicans performed with another identity group, namely women. A wonderful thing about women - well there are actually many - is that they are widely spread across all ethnic groups and every state, including important swing states such as Ohio, Virginia, Pennsylvania, New Hampshire, Wisconsin and Michigan. Needless to say, Republicans will need to win there if they are to prevail in a national election. Perhaps grooming more qualified female candidates to run for office at all levels of government and particularly in the swing states, would be a more effective long term strategy than pandering to a particular ethnic group at the cost of a broader principle.
Apart from the occasional scandal, the “fiscal cliff” will continue to obsess Washington over the coming months. The president’s initial approach to the matter is instructive as it represents a confirmation of the intentions surrounding his “legacy.” By seeking $1.7 trillion in tax increases rather than the $800 billion that was being discussed in an earlier round of negotiations with the Republican leadership, he has effectively upped the ante. Some may argue that this declaration is merely an opening gambit to steer the debate toward the highest level possible of targeted tax increases and ultimately, cooler heads will prevail. Perhaps, but it seems more likely that the president will remain fixed on securing as much of his original entitlement agenda as possible.
In the end, of course, some compromise will be reached because it is a political imperative for both sides. Tax rates will be raised and limited cost cutting agreed to in order to avert this self-inflicted “crisis.” Likewise, the federal debt “limit” will continue to be raised in regular increments even as the theatrics surrounding each round continue on both sides. The Republicans seem to feel they have too much to lose by shutting down the government and at least something to gain by harping on the obvious dangers associated with our mounting national debt.
The Road to California
Obscured in much of the public discussion and irrespective of the final compromise is the fact that current financial trajectory of the federal government will not change materially. Whether we seek $100 billion more in annual revenue increases from “the rich” and cut $100 billion or more from the annual budget or both will only matter at the margin. For all the talk of grand bargains and a “ balanced” approach, the annual deficit will continue to approach $1 trillion throughout Mr. Obama’s presidency. As a consequence, at the end of four years the country will likely have closer to $20 trillion in national debt instead of the roughly $16 trillion we have today. California here we come.
Further ensuring this outcome is that as this article is being written, the United States is showing most of the signs of following Europe and Japan into recession. It is just not yet official and even the stock market has only recently begun to signal the trend. If enacted, the proposed increases in taxes on dividends and capital gains will only accelerate an exit from the stock market that is already underway on the back of earnings downgrades. Who says that politicians have no knack for timing?
Furthermore, the regulatory-driven costs associated with Obamacare, Dodd Frank, the EPA, and other government initiatives will continue to discourage hiring at the margin. And so, contrary to the view expressed by so many pundits that the economy is somehow healing on the back of improved consumer sentiment, it is more likely scenario that US - and world - growth will be lower next year than this year. As a consequence, real unemployment in countries like the US will likely rise rather than fall - accompanied of course, by the usual hand wringing. This also means that the forecasts for tax revenue capture published by the Office of Management and Budget will continue to be revised downward even as tax rates are raised.
So the first thought provoking implication of Obama’s reelection is that the interest coverage ratio of the US federal government which measures its ability to service interest payments out of tax revenues will fall materially by 2016. A deterioration of at least 20% would not be surprising and that, of course, assumes interest rates do not rise. The short term nature (around four years) of so much of our federal debt ensures that interest costs could rise very rapidly once rates begin to price in the onset of stagflation. Students of history may recall that parts of Asia faced a similar problem during the “Asian crisis” of the early 90s. Indeed, as others have pointed out, were interest rates to rise to their long term average, one could easily see a quarter or more of tax revenues dedicated to servicing it.
Thus, the US government is destined to become still less creditworthy. Should federal debt be downgraded along the way? Obviously; will that happen? In time, but it is difficult to know when, as that is such a politically charged issue. Interestingly, it is that few seem to talk about the prior downgrade now even though it may be the single most significant event of the Obama presidency.
Meanwhile, under Mr. Bernanke and his likely successor, The Fed’s more or less permanent rescue operation is set to continue. Mr. Bernanke is due to step down in 2014, and it is difficult to imagine Mr. Obama appointing anyone other than a monetary dove to the post. Perhaps Ms. Yellen would fit the bill as she is already speaking of keeping interest rates near zero through 2016. This policy can only lead to further depreciation of the US Dollar over time. That depreciation will continue to be reflected, even if in fits and starts, in the rising price of gold over this period—and even though its price has already more than doubled since 2008.
Along the way, the Fed will continue to defend its actions under the guise of reducing unemployment. Internally, of course, the Fed gnomes know better as the occasional dissenter has publicly pointed out. Unemployment, alas, will respond no more obediently to the low interest rate policy in the next four years than it has over the last.
So why continue with the facade? Well, this is where it gets interesting. One reason could be that from a public relations perspective, it is imperative for the Fed to be seen to be doing “something” about this vexing economic problem. Alternatively, however, there may be a larger game going on here.
According to some schools of thought, debasing the dollar could actually solve a raft of problems. For example, in theory it could solve our chronic trade deficit by making imports more expensive and our exports more price competitive. And indeed, US exports have grown apace in recent years. Unfortunately, the trade deficit remains large for a whole host of reasons and, as of this writing, has grown at a steady clip in recent months. That the policy also punishes savers, inflates commodities prices, and renders all traded asset prices more volatile is, well, downright annoying.
Follow the Leader
Also awkward is the fact that most other industrialized countries have reacted to these methods with their own programs of monetary easing. Indeed, a number of pundits have already spoken of a new currency war among the major economies as the rest of the world tries to keep up with the breathless pace of monetary debasement set by the Federal Reserve. As a consequence, inflationary pressures are building across the whole globe.
Longer term, another attraction of debasing the dollar also reduces the real cost of servicing or paying off the trillions we now owe to foreign governments - especially in Asia. That is the seductive appeal of seigniorage. Our debt is denominated in ever depreciating dollars relative to the lender’s currency. They lose on their investment what we gain in debt forgiveness, a decidedly great deal for as long as the arrangement lasts. But for an administration which has often advocated for debt forgiveness, this does not seem like much of a stretch. Why not apply the same advocacy to the biggest debtor of them all, Uncle Sam?
For their part, Fed officials themselves staunchly maintain that inflation - or more likely - stagflation is a distant threat and what is more, they in theory can act quickly to mop up liquidity. After all, they have $trillions in bonds to sell. The real question is, will they? They know as well as anyone that allowing interest rates to rise too quickly would hamper the economy as well as raise our federal debt servicing costs dramatically. They know too that the students and their parents would balk at servicing the rising cost of some $1 trillion in student loans which is already outstanding and growing rapidly as we speak. In that harsh media-enhanced light, therefore, they have every reason to act gradually and more likely than not, belatedly. This, after all, is the same group that failed to see a problem with the subprime mortgage market until after that debt bubble burst. So, a final big implication of current fed monetary policy is that over time, the Fed will be slow to remove the monetary punch bowl even as it has ever less room to maneuver in order to stave off the onset of stagflation.
No One Likes to Diet - Not Even Voters
Already forces have been unleashed during the Obama administration that will weigh heavily on U.S. prosperity for the next four years and beyond. The role of the dollar as the world’s chief reserve currency will increasingly be questioned. There may even be rumors of the US defaulting on its national debt.
Internationally, budgetary shortfalls will strain the ability of the United States to serve as the world’s policeman. Domestically, the real cost of high spending/loose monetary policies will become apparent and voters will react. Continued high unemployment, slow growth, and ultimately, stagflation will not be allowed to persist indefinitely. The party in power will eventually be punished at the polls. It was, and will be, ever thus. Whether the prospect cheers Republicans or not, they will likely get another shot at dominating national policy sooner rather than later. That, arguably, is the easy part. The harder part will be handling the voter backlash that is sure to follow on the heels of instituting the fiscal, regulatory and monetary counter measures that will be needed to bring the country back to prosperity.
That said, one way to broaden their support among voters on a more sustainable basis would be to groom more qualified women for office now. Failing this, republicans risk being voted out as quickly as they were voted in.