10/27/2010 3:19 PM ET|
Don't blame Obama for this mess
Meltzer, a Carnegie Mellon University professor of political economy and the author of "A History of the Federal Reserve," told me over the phone that he believes the current obsession with more economic stimulus from the Fed (something he views as dangerously foolish) is the result of policy errors by the White House. Indeed, he boils it down to a simple equation: Obama's missteps are causing Fed Chairman Ben Bernanke's missteps.
Meltzer believes more fiscal stimulus is the answer. He suggests a moratorium on tax increases and new regulation. That would let businesses and households stop worrying about increased costs for energy, health care or financing and instead focus on growth. It would also take a lot of uncertainty off the table.
He also sees parallels to Franklin D. Roosevelt's anti-business rhetoric of the late 1930s in Obama's railing against the excesses of Wall Street "fat cats." Some of this has been pure politics; the bailed-out bankers at the center of the financial meltdown aren't a popular group. But Obama's broadsides have turned off a much broader segment of the business community.
The big question for Meltzer is whether Obama can move to the political center with both his rhetoric and his policies. And for that, the composition of the next Congress will play a big role.
Why this isn't 1994
Currently, the Intrade prediction market puts the odds of a Republican takeover of the House at a solid 88%. The odds of a GOP Senate victory stand at 58% but have been slipping since August.
With the Democrats poised to lose at least one house of Congress, it will become effectively impossible for Obama to pass sweeping legislation on energy or labor practices, or a new stimulus package that focuses on spending. This would greatly reduce the uncertainty about new regulatory burdens on businesses and households. That's good news from an uncertainty perspective -- frequently cited as a reason for lackluster hiring by the private sector.
This outcome would also increase the likelihood that the George W. Bush tax cuts would be extended for everybody, including the rich. Many would disagree with that policy, but it's a plus at least in terms of eliminating another uncertainty.
But there's also a risk that Republicans will damage the recovery with an overzealous focus on the budget and the national debt. As discussed in my column last week -- "Could the Tea Party save the economy?" -- the rise of that movement may force the Republican Party to prematurely focus on fiscal consolidation. Already, the slow withdrawal of stimulus-package spending will subtract 0.5% worth of GDP growth in 2011.
Economist Aneta Markowska at Société Générale warns of parallels to the big Republican victory in the 1994 midterms. Although the election forced Clinton toward the center and focused the government on trimming the deficit, the economy was much more robust then and was able to handle the strong medicine of tax increases and spending limits. We were in the early days of the debt-fueled growth story that helped inflate the tech and housing bubbles. We don't have that tailwind now.
In Markowska's words, the "private sector is suffering from an acute demand shortage." If the government cuts spending now and consolidates its finances prematurely, the economy could tip back into a recession.
There are solutions. For one, the fact the U.S. Treasury sold $10 billion worth of inflation-protected bonds for a negative interest rate of -0.55% on Monday is a sign that plenty of borrowing capacity remains. Thanks to ultralow interest rates, the government is spending the least on interest payments since the mid-1970s.
This leaves room for additional short-term fiscal stimuli, most likely in the form of full extension of the Bush tax cuts -- which, if removed altogether, would shave 2% off 2011 GDP growth, or 0.5% if they expired for just the rich, according to Markowska's estimate. By keeping them in place, taking into account the steady withdrawal of the $787 billion American Recovery and Reinvestment Act, the economy would receive a boost of 1.5% next year.
Other possibilities, with bipartisan support, include restoring and making permanent a research-and-development tax credit that expired last December -- something that was proposed by Obama in September. Extension of emergency unemployment benefits is another likely candidate.
But all this presumes the two parties can put aside the past two years of bad blood, which is an exercise in optimistic thinking.
The presidential cycle
And what does Election Day portend for investors and the stock market?
Whatever happens to Obama, the Tea Party and Congress, history suggests stocks should post impressive gains in the third year of a presidency. This makes sense, since the president is motivated to get a flagging economy going again before standing for re-election in less than two years.
In fact, according to Jeffery Hirsch and the team behind the Stock Trader's Almanac, there hasn't been a down year in the third year of a presidential term since 1939, when Hitler was marching into Poland. Most bear markets occur during the first or second years after a presidential election. Then prices typically turn higher.
Here's the exciting part: The fourth quarter of the midterm year and the first quarter of the pre-election year are the "sweet spot" in the four-year presidential cycle. Since 1949, the average gain in this period has been 14.4% for the Dow Jones Industrial Average ($INDU). For the Nasdaq Composite Index ($COMPX), it's been a whopping 24% since the exchange was founded in 1971.
Hirsch believes these trends will be particularly strong this time because Obama will be fighting an uphill battle into the 2012 election. That will help grease the wheels of the legislative process. Democrats will need to work more effectively with their Republican colleagues on new stimulus ideas. And Republicans, no longer entirely a minority power, will want to engage and show progress on their new mandate. Expect common ground to be found on infrastructure investments and tax cuts.
Either way, and assuming there isn't another Greek-style financial tragedy looming, these efforts should go a long way toward restoring both the economy and Obama's approval numbers.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at email@example.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
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