The election of your lifetime.
That’s what the vote on November 2nd vote has been called. It’s probably a fair description in many, many policy areas. The two major party nominees for President differ on a host of issues, ranging from international affairs to economic strategy to tax policy. Even on basic issues of science – stem cell research (biology), global warming (chemistry), missile-defense (physics) – there are huge distinctions between the Republican and Democratic candidates.
When it comes to the capital markets, conventional wisdom assumes that the outcome of this election will matter a great deal.
Why? There are simply far too many structural factors that will hamstring whoever assume the Office of Presidency on January 20, 2005. The post-bubble environment has problems that will likely be cured only by the passage of time. Large budget deficits will continue, as will the ongoing weakness of the dollar. The economy is likely to grow, albeit at only a very modest pace, for the foreseeable future.
Further, U.S. presidents have far less influence over the macro-environment than most believe. The United States economy is a multi-trillion dollar behemoth, and its business cycle is not readily changed by minor – or even major – course corrections.
Consider the environment the president-elect steps into: With the 2003 stimulus fading, the economic expansion has already started to slow down. The trend of the past four quarters of GDP growth is revealing: 7.4% in the third quarter of 2003, 4.2% in the fourth quarter, 4.5% in the first quarter of 2004, and 3.3% in the second quarter. The end of the softspot was supposed to be 2004′s 3rd Quarter GDP — that came in below consensus, at a (disappointing) 3.7%.
This movement is even more pronounced if we back out government spending on military and wartime explanations.
Unless another trillion-dollar stimulus package is forthcoming – and given the huge deficit, that is highly doubtful – economic growth will be in the 2.5% to 3% range.
And that’s without factoring in the impact of $50-plus-a-barrel crude.
So far, it’s been the consumer who has kept this recovery going, via advantageous interest rates and home-equity refinancing. At this point in any recovery, 36 months after the recession’s official end, we should be seeing the corporate half of the equation ramping up. But we are not. What we hear from CEOs during earnings conference calls is not particularly encouraging, with the focus on cost-cutting and “hitting their numbers.” They are not very sanguine about 2005, expecting little in the way of expansion. Few are announcing increases in capital expenditures; fewer are stating their intentions to ramp up hiring.
For those who were hoping for a robust expansion, this trend is troubling.
Consumers cannot carry the entire economic burden themselves. For the recovery to continue, it needs to be organically self-sustaining – i.e., not reliant on government stimulus and handouts. For that to occur, the economy requires new jobs and CapEx spending.
In these circumstances, the impact any president would make is at best modest – and mostly at the margins.
The Postbubble Environment
In the run-up to the tech/telecom/Internet bubble, a tremendous amount of overcapacity was created through massive over-investment. This is enormously important for the future of the present economic recovery. Why? Companies will not hire or buy new capital goods unless they need to in order to meet increased demand. That won’t happen when their customers have warehouses full of those very same goods.
Consider what the National Bureau of Economic Research – the group responsible for dating the beginning and end of recessions – has to say about it: “One could define expansions and recessions in terms of whether the fraction of the economy’s productive resources that is being used is rising or falling.”
In other words, watch to see whether our excess capacity is improving or not. We have significant excess capacity, which does not appear to be responding to all the stimulus being thrown at it. As long as weak demand limits any improvement in these lowered utilization rates, expect GDP to remain anemic.
There is little need for any capacity utilization increases. Less factories will get built, fewer workers hired. The economy will continue to struggle under an anemic expansion – until the excesses get worked off.
Conservative economist Arnold Kling looks beyond the industrial utilization rates to LUCY – the Labor Capacity Utilization Index. LUCY suggests there are broad and deep structural issues within the labor market that have yet to be resolved. That does not bode well for job creation in the near future.
What does all this economic gibberish mean to whomever gets elected? First, the economy remains a long way from its potential. Kling argues it will “take years to eliminate all of the slack in the labor market.” Second, unless the Fed continues to apply stimulus aggressively, GDP will remain low – and possibly keep falling. And third, we are very likely to see large budget deficits for at least three or four more years.
The Japanese Model
The closest comparable to the post-bubble U.S. is Japan in 1989-2003. After its bubble popped, it took Japan 14 years to work off their excesses. It didn’t matter much who got elected, the cure was very low interest rates – and time.
That’s the bad news. The good news is that we learned from Japan’s mistakes. To its credit, the Federal Reserve cut rates more quickly and more deeply than did Tokyo’s Central Bankers.
Compared with Japan, we’re not so bad off:
Ten Years After
A lesson for the U.S. in Japan
This means it shouldn’t take the U.S. the same 14 years Japan needed to get through its post-bubble nightmare. With any luck, the excesses from the ’90s should be worked off by 2008 – perhaps in time to have this same debate all over again during the next Presidential election.
Whoever gets elected in 2004 will have many significant economic decisions to make. He will appoint the next Federal Reserve Chairman, influence tax policy, and affect a host of regulatory issues. But none of these issues will rise above the broader structural environment we presently are mired in.
Significant philosophical differences exist between these two men. And on a variety of issues – from stem cell research to global warming to missile-defense – their views, policies and political appointments will matter a great deal.
As to the capital markets over the next four years? Hardly at all.
An earlier version of this column was previously published at TheStreet.com
on October 27, 2004
Recession Dating Procedure
Business Cycle Dating Committee, National Bureau of Economic Research
October 21, 2003
I Love LUCY
Tech Central Station, 08/08/2003
INDUSTRIAL PRODUCTION AND CAPACITY UTILIZATION
Federal Reserve Board
October 15, 2004
Can Japanese Rates Happen Here?
10/26/2004 9:10 AM
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