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Initial Thoughts on the Obama Budget

I was on the BBC this morning talking about the Obama FY 2012 budget proposal. Here’s what I said and what I think about the proposal so far (If I get the video, I will post). This post will be more about the political tactics and positioning than about advocating a specific policy course since the budget and the framing of its objectives is a purely political process. I will give some broad strokes on the advocacy front, however.

The Obama Agenda

Clearly, President Obama is in full re-election mode now – and that means everything he does from here on out will be done with an eye to how these policy moves will be perceived in a 2012 general election. The Obama budget shows a lot more budget cutting than the President announced during the State of the Union address last month. This is probably by design because the President wants to exceed expectations on the deficit cutting front to paint himself as fiscally responsible in his efforts to beat back the Republicans efforts to paint him as a tax & spend liberal.

The headline the Obama Administration wants voters to focus on is this: Barack Obama budget to cut deficit by $1.1 trillion. That’s how the Daily Telegraph put the budget – and that’s exactly how the Obama people wish the U.S. media would put it.

The key, however, is that no one actually wants to cut the items in the budget which account for the lion’s share of spending: defense, Social Security, and Medicare. Now, if the President were a lame duck or if this were the first Congressional term in his tenure, he could take these issues on. But, cutting any of these areas is not likely to win voters. So, the President is forced to cut more deeply into non-military discretionary spending in order to position himself as fiscally responsible.

This is causing a negative reaction in progressive circles. New Deal 2.0′s Rob Johnson writes:

the President seems content to conform to the prevailing suspicion of government. He fails to convince the public that the government can have an active response to the jobs crisis that benefits them.

And that suits many funders in the top 3 percent of the wealth distribution just fine.

With profits so high and so many slack resources, it is sad that President Obama continues on the path of “triangulation” and chooses to “pre-concede” so much to the Republicans. In electoral terms, the breaking of all of the unions at the state and local level will serve to benefit the Republican party in many regions and exacerbate inequality. It is surprising the the President does not resist this for the benefit of his own party’s future. But Presidents often fly solo rather than represent their party when reelection looms — especially in a post-Citizens United world that will be influenced by unprecedented rivers of money.

I differ with Rob on some of the specific policy prescriptions. But I think he certainly has the politics of the budget right.  Corporatism is going to be an even bigger issue in 2012 than ever before in the wake of the Citizens United case. So the President wants to present as business-friendly a face as he can in order to maximize his fundraising efforts.

The Republican Agenda

On the other hand, the Republicans would like to attack Obama where they see him as weakest. Here’s how I put it in October:

In the US, the Obama Administration will soldier on at least through 2012.  In all likelihood, Congress will become more Republican. This means that after the mid-term elections, Congress will often want to demonstrate how terrible a job the Obama Administration has done in fixing the economy. It can only do this by focusing on policies which exaggerate differences: stimulus, bailouts, health care (correct me if there are other areas you think I missed).

So this will mean Republicans will show extreme opposition to any stimulus, any bailouts and may look to rescind the healthcare bill already passed by whatever means necessary. Likely, stimulus is out for good now.

I think this logic is still very much at work today. I would say, however, that Obama’s economic agenda for re-election is more geared to the Democratic base than I was saying it would be in October and November.* Does this open the President up for attack by Republicans? John Boehner seems to think so. We’ll have to wait and see how this plays out. The debt ceiling issue, which will come to a head in the next few months, will be a good place to see all of this positioning come to a head. I anticipate it could be a make or break moment for both the Republicans in the house or for the Obama Administration.

This plays well for Obama so far

The attacks from both sides make Obama look like a centrist – exactly what he is looking for. Right now, as far as the Clintonistas in the White House are concerned, 2010 was a replay of 1994. And that mandates the same tack to the center in order to win re-election.  My view is that this could work for Obama if the economy holds. At this point in the economic cycle, I believe 2012 is going to be more of a referendum on the economy than specific policy prescriptions.

As far as policy goes, I largely agree with the thrust of this statement from Tom Ferguson:

Addressing long-term budget issues requires bringing US health care costs in line with those of other major countries with better records on providing adequate services to their populations. That is not done by fixing inflexible spending limits, but by allowing the government to bargain with Big Pharma over drug prices and making health insurers actually compete. In the long run, we probably need a … system that eliminates all the wasteful duplication in medical forms, advertising, etc, that pass on costs to the consumer. If you also rein in military spending and regulate banks to prevent another financial crisis from wrecking both the economy and the budget again, much of the deficit problem disappears. Then you can admit the truth of what close students of Social Security already know: That there is no problem with that program for decades.

U.S. healthcare spending and spending results, as measured by things like life expectancy, are wildly out of line with every other developed economy in the world. See The correlation between healthcare spending and life expectancy. Clearly, the U.S. is doing something wrong. I would argue, it is another case of corporatism – favouring Big Pharma and the healthcare insurance lobby. The question then goes to policy prescription in solving this, where there are lots of ideas.  Where I have the … in the previous quote, Tom says single payer is the key here. That is definitely one position. At a minimum though, the healthcare reform bill did not address the fundamental budgetary concern, which is healthcare costs increasing faster than economic growth. And nothing Obama has proposed this year solves this dilemma. I’ll leave it at that.

On the Social Security issue, progressives believe the agenda for entitlement reform is orchestrated by corporatists and they resist these efforts.  Tom actually says "there is no problem with that program for decades, if ever."  I left that last part off because I think this is the crux of the matter. I do think healthcare is a problem, Social Security as well, but much less so (see here). I would say jobs are the first priority because most of the deficit disappears in an economy operating at full employment.

Thoughts on economy

Switching to the economy, it is interesting to remark how the rise in stocks, especially technology shares, has underpinned the jobless recovery as it did in the early 1990s.  To date, most of the IPO talk that mirrors the IPO talk of the 1990s has been about larger profit-making enterprises. And that’s a good thing.  However, I have noticed a gold rush mentality forming in tech.  Increasingly less mature companies are popping up as IPO candidates.

For example, Pandora, a great Internet-based music company that  use religiously is going to market. I love Pandora. The problem is that Pandora is a loss-making company, heavily dependent on advertising, which means that it is not only unprofitable but also has a high degree of operating leverage. When the next downturn hits, the company needs to have scaled in order to reduce the negative impact this leverage will have on margins.

VC Fred Wilson voices his opinion on why he won’t invest in Pandora:

It has to be be both a large network and engaged users. By that requirement, he says he wouldn’t invest in Pandora (which just filed for an IPO yesterday, although this was taped a couple weeks ago) because Pandora listeners just sit back. The users aren’t doing anything in Pandora,” he says, “even though Pandora is a great company.

Other examples of technology moving well into bubble mode come from the increasingly feverish technology fund raising activity. All of this is underpinned – as it was in the 1990s – by easy money, excess liquidity, and low interest rates. Investors need to take on more risk in order to make the nominal returns they have targeted in a low nominal interest-rate environment. The Bernanke Fed is telling punters they can do so because the Fed will keep the U.S. on easy street for the foreseeable future. And that always means projects which have longer lead times and where profits are further out into the future are going to disproportionately benefit. This reallocates investment capital to projects and firms that require high levels of capital spending or that are in earlier stages of development. This is exactly why Pre-IPO companies are in favour.

Right now we see the best opportunity in the last 15 years for venture capital investors to cash out. It makes sense that they are doing so. But, make no mistake: this is malinvestment, pure and simple. And while some will find this a huge bonanza, many others will make huge losses when the malinvestment comes a cropper.

For the U.S economy as a whole I see this period as much less benign than the 1990s. Debt levels are higher in both the public and private sector and interest rates are lower. That means there is less space for accommodative policy to work against a malinvestment-induced debt deflation in the next downturn.  What I see happening is a relapse into recession that reveals unsustainable debt loads at the state, local and household level. With reflationary policy options reduced, policy makers will either need to go all-in (buying municipal bonds, stocks, houses, printing money, employing unemployed directly, etc.) or we are going to se a very nasty downturn. Right now, policy is geared to maintaining enough traction to get through the election cycle. This will only make the next downturn more severe. And unless we see higher rates (and, thus, room to cut) coupled with a big reduction in debt levels at the state, local and household level before the next recession, the next go round is going to be will be when the next crisis hits. (Apologies for the downbeat conclusion on the fundamentals, but that’s how I see it. Comments appreciated).

For now, the economy looks pretty good. If the President can burnish his pro-business bona fides and maintain the attacks from the right and the left, he will be able to present himself as a pragmatic centrist who pulled the U.S. out of a near-depression. That could be a winning argument in 2012, regardless of the underlying fundamentals.

——————————–

*I should also use this as an opportunity to admit I was wrong regarding inflation in the UK –not that I like doing so. But I figure I have to point out where I have been wrong as well as where I have been right, if I want to be an honest broker of news and opinion. If you look back at my October post on politics in the UK and the US, I was saying that inflation would recede. It has not receded.  In other respects, I stand by the analysis from that post.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

8 Comments

  1. Anonymous says:

    Edward,

    Care to take a guess on when you see the next economic downturn happening? I have a hard time seeing it happening this year. 2012 and/or 2013, though, is a different matter.

    Also, since you’ve moved into a more forecasting mode on this blog, what do you think some of the “indicators” might be that will be warning signs of the next approaching downturn? One of the more typical “warning signs” – housing starts – obviously isn’t going to be much help as an indicator, considering the low starts we have now and likely will have for the next 1-2 years.

    • Jim, Hi. We could start to see some weakness already in the second half of 2011. My sense tells me the animal spirits are enough to carry us through 2011. The question is whether that next downdraft would be the beginnings of the next real cyclical downturn and will it be strong enough down by November 2012.

      At this point, it would be hard to say. But I don’t see this cycle lasting for long because the fundamentals are so poor (high household debt, poor employment growth, housing overhang, etc). What I look for is second derivative stats (change in the change). I look to employment, manufacturing, and retail sales mostly. So if I se the change in jobless claims up at +50,000 and the ISM manufacturing index change accelerating down and the pace of growth in retail sales diminishing those are warning signs. You need to see those signs across a wide array of areas for a few months to know the downturn is coming.

      See here for some of the thinking on that:

      http://www.creditwritedowns.com/2008/10/economys-four-horsemen.html

    • One other thing : last year many of the issues were the same. Without quantitative easing who knows where we would be. I said a double dip was likely. And until QE it was. So from a purely cyclical perspective QE has underpinned the recovery. That’s nice. But from a structural perspective I would like to have seen something much more geared to jobs and the real economy. QE is not good policy.

      • Anonymous says:

        You think there’s a good possibility of a QE3 happening next year? If QE2 is indeed holding up the economy, when it ends, it seems likely we’ll see a slump. Could the Fed wait 3-6 months, see the softening in the economy, and launch QE3? Since late 2011/early 2012 will be prime election season, I would imagine that the political pressure to launch QE3 might be quite strong.

  2. jimh009 says:

    Edward,

    Care to take a guess on when you see the next economic downturn happening? I have a hard time seeing it happening this year. 2012 and/or 2013, though, is a different matter.

    Also, since you’ve moved into a more forecasting mode on this blog, what do you think some of the “indicators” might be that will be warning signs of the next approaching downturn? One of the more typical “warning signs” – housing starts – obviously isn’t going to be much help as an indicator, considering the low starts we have now and likely will have for the next 1-2 years.

    • Jim, Hi. We could start to see some weakness already in the second half of 2011. My sense tells me the animal spirits are enough to carry us through 2011. The question is whether that next downdraft would be the beginnings of the next real cyclical downturn and will it be strong enough down by November 2012.

      At this point, it would be hard to say. But I don’t see this cycle lasting for long because the fundamentals are so poor (high household debt, poor employment growth, housing overhang, etc). What I look for is second derivative stats (change in the change). I look to employment, manufacturing, and retail sales mostly. So if I se the change in jobless claims up at +50,000 and the ISM manufacturing index change accelerating down and the pace of growth in retail sales diminishing those are warning signs. You need to see those signs across a wide array of areas for a few months to know the downturn is coming.

      See here for some of the thinking on that:

      http://www.creditwritedowns.com/2008/10/economys-four-horsemen.html

    • One other thing : last year many of the issues were the same. Without quantitative easing who knows where we would be. I said a double dip was likely. And until QE it was. So from a purely cyclical perspective QE has underpinned the recovery. That’s nice. But from a structural perspective I would like to have seen something much more geared to jobs and the real economy. QE is not good policy.

      • jimh009 says:

        You think there’s a good possibility of a QE3 happening next year? If QE2 is indeed holding up the economy, when it ends, it seems likely we’ll see a slump. Could the Fed wait 3-6 months, see the softening in the economy, and launch QE3? Since late 2011/early 2012 will be prime election season, I would imagine that the political pressure to launch QE3 might be quite strong.

  3. fresno dan says:

    “With profits so high …”
    I sure wouldn’t mind taxes being raised – at some point reality has to interlude between what we want and what we pay for.
    But from what I have read, the idea that there is all this money private sector profits sloshing around…from who? What with a high percentage of profits from finance (the right hand gives the left hand which gives the right hand) I don’t see the efficiency of raising taxes just to give the proceeds back to JP Morgan some more. And what about GM and those inventories? Not to mention the recent change in ACCOUNTING RULES, by which I could value my 2001 Hyundai Sonata at 362,872.84$ (its a classic).
    How many firms in the US are really highly profitable? And how many are highly profitable due to actually making or selling something and not due to 0.25% money from the Fed which is used to buy bonds yielding 4%? Isn’t GE really a finance company? How many of those can we have?
    Republicans have waste, fraud, and abuse, Democrats have highly profitable companies – which all seem to be getting their profits due to free money from ….the government.

  4. fresnodan says:

    “With profits so high …”
    I sure wouldn’t mind taxes being raised – at some point reality has to interlude between what we want and what we pay for.
    But from what I have read, the idea that there is all this money private sector profits sloshing around…from who? What with a high percentage of profits from finance (the right hand gives the left hand which gives the right hand) I don’t see the efficiency of raising taxes just to give the proceeds back to JP Morgan some more. And what about GM and those inventories? Not to mention the recent change in ACCOUNTING RULES, by which I could value my 2001 Hyundai Sonata at 362,872.84$ (its a classic).
    How many firms in the US are really highly profitable? And how many are highly profitable due to actually making or selling something and not due to 0.25% money from the Fed which is used to buy bonds yielding 4%? Isn’t GE really a finance company? How many of those can we have?
    Republicans have waste, fraud, and abuse, Democrats have highly profitable companies – which all seem to be getting their profits due to free money from ….the government.

  5. Rob says:

    “If the President can burnish his pro-business bona fides and maintain the attacks from the right and the left, he will be able to present himself as a pragmatic centrist who pulled the U.S. out of a near-depression. That could be a winning argument in 2012, regardless of the underlying fundamentals.”

    True. The real question is when the does the bond market finally gets spooked (be it due to inflation, the realization that deficits are not likely to go down “organically” nearly as much as forecasted together with the realization that there is no political will to deal with them in any significant manner but at the same time politics will not allow a QE3, or due to some other unforseen event – in the US or abroad). If that happens before fall 2012 then Obama stands no chance.

    With half of US debt rolling every year, just a couple % move in interest rates is enough to cause a giant fiscal crisis.

  6. Rob says:

    “If the President can burnish his pro-business bona fides and maintain the attacks from the right and the left, he will be able to present himself as a pragmatic centrist who pulled the U.S. out of a near-depression. That could be a winning argument in 2012, regardless of the underlying fundamentals.”

    True. The real question is when the does the bond market finally gets spooked (be it due to inflation, the realization that deficits are not likely to go down “organically” nearly as much as forecasted together with the realization that there is no political will to deal with them in any significant manner but at the same time politics will not allow a QE3, or due to some other unforseen event – in the US or abroad). If that happens before fall 2012 then Obama stands no chance.

    With half of US debt rolling every year, just a couple % move in interest rates is enough to cause a giant fiscal crisis.

  7. Rob says:

    Understood, but I am wondering from a political prespective how long can the FED play the expasionary game.

  8. Rob says:

    Understood, but I am wondering from a political prespective how long can the FED play the expasionary game.