Markets & economy

America as seen from afar

The United States is of critical importance to all investors regardless of where they are domiciled. It is the world’s largest economy, the powerhouse of technical progress, and the dollar is the world’s reserve currency. Its equity markets account for 64% of the market value of global equities. Accordingly, the impact its recent election will have on its economy is highly relevant. On politics there are usually as many opinions as there are commentators. What follows is Sandy McGregor’s personal view of this important topic.

In the two decades following the Second World War, the Italian journalist Giovanni Guareschi wrote a popular series of books about Don Camillo, the parish priest of a small fictional village in the Po valley. The political control of the village was fiercely contested by the Christian Democrats, effectively under the leadership of Don Camillo, and the Communists led by the mayor Peppone. However, despite their differences, the villagers would unite to oppose what they regarded as unacceptable interference in their affairs by outsiders. As former Speaker of the US House of Representatives Tip O’Neill memorably said: “All politics is local.” 

However, there is another facet to this truism. As is not uncommon among politicians, Peppone was prone to make speeches laced with mixed metaphors. One of his favourites was “the nemesis of geography”. This phrase captures an important feature of any democratic polity: Voters’ political attitudes are profoundly influenced by where they live. Most electoral maps of a democracy show great swathes of contiguous territory where the majority supports a particular political party. While in a village such as Don Camillo’s people know their neighbours and can make the compromises required to resolve local disputes, this becomes increasingly difficult as issues become more distant, complex and abstract. 

A divided United States

Currently this phenomenon is notably visible in the United States, where the nation has divided into a Republican heartland covering 25 states mostly located in the continental interior, and 25 Democratic states on the Pacific and Atlantic coastal peripheries and in the Great Lakes region. National politics has become increasingly fractious. The two preeminent political parties, divided as they are not only by ideology but also by geography, have proved to be increasingly unwilling to make the compromises which a functioning democracy requires. 

This is not the first period in which US national politics has been so divisive. There have been many others. The most recent episode was during the Vietnam war, which provoked similar passions, but these were between the youth who faced conscription to fight in an unpopular war and the intelligentsia on the one hand, and mainstream conservatives on the other. The issue of Vietnam transcended national geography. In 1967, Walter Lippmann, who was then America’s leading political commentator, found the political climate in Washington DC so poisonous that he abandoned a city in which he had been happily resident for 30 years, saying what America needed was comity. This seldom-used word means respect for the opinions of others. Certainly,  the current US political system is seriously deficient of comity. 

Donald Trump’s achievements

Donald Trump’s victory in the 2016 presidential election was partly due to his opponent Hillary Clinton being such an unattractive candidate but was largely a consequence of growing unhappiness about the quality of life of ordinary people within Middle America. While many outside the United States thought President Barack Obama performed well in his representative role as a head of state, this counted little in domestic politics. Once the Democrats lost control of the US Senate in 2010, Obama attempted to implement his agendas using presidential orders. His administration significantly compounded the complexity of doing business with the consequence that less business was done. 

Obama’s eight years of office followed the severe economic downturn caused by the financial crisis of 2008. During this period, the US economy failed to regain the economic buoyancy that characterised the first decade of this century. In his presidential campaign Trump highlighted this economic failure and promised that he, as a businessman, could fix matters. And indeed, the past four years have seen a more robust economy and, prior to the COVID-19 pandemic, a return to full employment. 

Two actions taken by the Trump administration played a significant role in promoting this prosperity. Firstly, by cancelling numerous earlier presidential orders there was substantial deregulation, which facilitated doing business. Secondly, when the Republican Party had a majority in both the Senate and the House of Representatives between 2016 and 2018, it pushed through a significant tax cut.

While a reduction in tax collections will have adverse long-term consequences as fiscal deficits accumulate, in the short term these two actions more than compensated for the adverse impact on the economy of Trump’s disruptive style of government. Corporate earnings grew strongly. The Trump administration was popular among investors and those who managed and operated businesses.

Voters' political attitudes are profoundly influenced by where they live

The 2020 election

Historically an incumbent American president has been vulnerable when running for a second term if economic conditions in the election year are poor. Notable casualties include Jimmy Carter in 1980 and the first George Bush in 1992. Accordingly, Democrats were optimistic about their party’s prospects in the aftermath of the deep recession triggered by the COVID-19 pandemic. Their hopes were buoyed by their success in regaining control of the House of Representatives in 2018, Trump’s often-bizarre behaviour and a strong lead in the opinion polls. The emotions stirred by events which led to the Black Lives Matter movement promised a large turnout of Black voters who traditionally support Democratic candidates. The prospects for a blue wave, which would sweep the Democrats into control of the presidency, the Senate and the House of Representatives, looked favourable. 

For the Democrats, the outcome of the 2020 election was initially disappointing. The Republicans did much better than expected. It seemed that the Republicans would retain control of the Senate by winning at least one and probably both the two Senate seats in Georgia following a runoff election. Gridlock would continue and Democratic programmes would be blocked. However, following the Georgia election, Democratic fortunes have improved. It seems that President Trump’s increasingly desperate attempts to overturn his narrow defeat by Joe Biden in Georgia helped mobilise a large turnout of supporters of the Democratic candidates to vote in the runoffs, which gave them a surprising victory. The congressional blue wave has materialised but by a very slim margin. The US Senate is now split equally between the two parties, each having 50 seats. As the vice president has the casting vote, this gives the Democrats a tenuous majority. After losing 10 seats in the House of Representatives, their majority in that chamber has been reduced to nine. 

There was a big turnout with 158.2 million votes cast in the presidential election, 21.5 million more than in 2016, but both parties benefited from this surge in voter commitment. While Biden received 81.3 million votes compared with Hillary Clinton’s 65.9 million, those supporting Trump increased from 62.9 million to 74.2 million. Trump broadened his support base, gaining a larger proportion of votes from women, Blacks and Latinos than previously. 

However, the American president is elected not by a popular vote, but by an electoral college, in which the 50 states and Washington DC have votes proportional to their populations. Every 10 years these are adjusted following a census. Biden replicated Trump’s achievement in 2016, winning 306 of the 538 electoral college votes. He won five swing states with a majority of 275 000 votes. In 2016 Trump won these states by 380 000 votes. Although the outcome was different, the 2020 election was remarkably similar to that of 2016. The conservative voting bloc, which made Trump president, remains intact. 

Immediately after the November election, Governor Andrew Cuomo of New York blamed his party’s poor showing on socialist agendas of leftists such as congresswoman Alexandria Ocasio-Cortez and the failure of New York City’s mayor Bill de Blasio to maintain law and order during the race riots of the preceding summer. While there has been pushback from those being blamed, it seems that Cuomo is at least partly correct. The Democratic Party platform did not resonate with the majority of voters.

Another indication of this innate conservatism of much of the electorate was the fate of various propositions put to voters in California. The repeal of a longstanding prohibition of affirmative action by state institutions was rejected, as were rent controls. Voters also overturned legislation requiring Uber and Lyft to make their drivers permanent employees. While California strongly supported Joe Biden for president, it voted on these propositions as would economic conservatives. Nationally Trump’s defeat was more a rejection of his many personal failings than an acceptance of his opponent’s agendas. 

The political consequences of the 2020 election

For the past two years US federal politics has been gridlocked because the Democrats controlled the House and Republicans the Senate. While there have been numerous similar precedents, what has made the recent episode of gridlock different is the noxious political climate, which makes compromise between the two parties so difficult. The remarkable denouement of the Trump administration, with the president refusing to accept the outcome of a democratic election and encouraging a mob of supporters to attack the Capitol to prevent Congress formally approving the election of his successor, was but one manifestation of deep political divisions.

the outcome of the Georgia election is a game changer in that it will allow at least some of Biden’s ambitious agenda to be implemented 

Theoretically, with the Democrats in control of both houses of Congress, President Biden will be able to implement his legislative programme, which includes a substantial increase in spending on the environment, infrastructure and education to be funded by higher taxation of business and of the rich. Majorities in both the Senate and the House will give the Biden administration control of the legislative programme. However, in practice the new president’s freedom to act will be constrained by his slim majorities. Senate rules require that legislation which increases the fiscal deficit obtain the support of more than 60% of its members. Not all Democratic members of Congress wholeheartedly support all aspects of the president’s agenda and will vote accordingly. In the current situation these renegades can have significant influence disproportionate to their numbers. It will require considerable political skill to manage this Congress, a task made more difficult by the lack of consensus on so many issues.

However, the outcome of the Georgia election is a game changer in that it will allow at least some of Biden’s ambitious agenda to be implemented. The share market has reacted positively because there is a widespread expectation that Congress will now increase the recently enacted stimulus cheques payable to individuals from US$600 to US$2 000 and seek to implement other aspects of a US$2.5tn stimulus programme supported by Democrats but blocked by fiscal conservatives in the Senate. As these measures are popular among voters, they will command bipartisan support. In the longer term, increased infrastructural spending may also garner similar support because this is a classic example of all politics being local. Infrastructural programmes tend to be favoured by the representatives of districts which benefit from them.

A significant proportion of the membership of the US Senate can be described as fiscal conservatives, largely Republican but also including a significant number of Democrats. As the pandemic recedes and the world returns to normal, these senators will seek to restore some discipline and traditional prudence to the conduct of the nation’s finances. Increasingly this will lead them into conflict with the Biden administration. It is not just a matter of differing political philosophies. Generally Republican-governed states are in a better financial condition than Democratic states. An important reason why the Senate restricted the recently passed stimulus programme to US$900bn and denied more lavish expenditures supported by the Democratic-controlled House was the argument that Federal taxpayers should not bail out states which are financially wasteful and imprudent. Such expenditures were seen as a transfer from those who manage their affairs well to those who do this badly. The divide is both political and geographical.

Among the few issues about which there is political consensus is that big businesses, in particular, large technology companies, have become too powerful and abuse their competitive dominance. Trump’s concerns about these companies were personal. He disliked organisations that gave money to his political rivals and censored what he could say on Twitter. The Biden administration concerns involve public interest, and it is likely to take advantage of its control of Congress to promote investigations into companies such as Amazon and Google and will launch antitrust cases.

Trump was an unusual president in that he espoused many causes which were not enthusiastically shared by his party’s representatives in Congress. For example, he was a fan of fiscal profligacy which, despite history which suggests otherwise, is hardly a mainstream Republican value. Using the power of the presidency and his popular support among Republican voters, Trump could make his supporters in Congress do things they would not normally do. The outcome of the 2020 election will promote a return by the Republican representatives in Congress to their traditional more conservative stance on national issues.

For the Republican Party, the most alarming consequence of the election is that all signs are that Trump is setting himself up to run again in 2024. At 78, his age will then be the same as Biden’s is currently. Probably, of all the candidates who sought the Democratic Party’s presidential nomination in 2020, Biden alone could have defeated Trump. The other leading candidates were too closely associated with policies which did not resonate with the majority of voters in the swing states. A plausible Republican candidate in 2024 would have a good chance of winning. However, while Trump commands such a loyal following in his party, it will be difficult for another candidate to emerge. The extent of his support is seen in the surprising statistic that between 50% and 70% of those who voted for Trump believe that he was somehow cheated out of victory. This support may have been dented by his astonishing behaviour in the final weeks of his presidency, but as long as Trump and his future is an all-consuming preoccupation of the Republican Party, American politics will continue to be poisonous.

the combination of fiscal deficits, aggressive money-printing by the central bank, and the availability of significant savings accumulated during the pandemic, is a formula for strong economic growth 

Economic consequences

When the results of the November election became known, financial markets responded favourably. Investors welcomed continuing gridlock which protected them against increased taxation and hostile legislation. Following the Georgia election markets again increased, suggesting that investors now think that ending gridlock will promote lavish fiscal spending which will stimulate the economy, and this will have far greater impact than any future tax increases. It is too early to make predictions about American fiscal deficits during the Biden administration. All one knows is the president and his party want to spend more, much more. 

In 2019 the US was already running a fiscal deficit of US$1tn per year, equivalent to 5% of GDP. Congress authorised a temporary increase to US$3.1tn during the 2020 fiscal year to provide for income support during the pandemic and in December 2020 authorised a further US$0.9tn for relief measures, which will push the 2021 deficit to about US$2tn, equivalent to 10% of GDP. The Democrats had proposed further expenditures of US$2.5tn which were rejected by the Senate. These unprecedented expenditures have been possible because they have been largely financed by the Federal Reserve Board (the Fed) which printed the money. 

Biden wants to spend more, but future deficits will depend on what he can get through Congress and what the Fed is willing to fund. Politicians like spending other people’s money but fiscal conservatives in the Senate will resist any attempt to significantly expand the deficit once the current crisis has passed. The funding of these deficits will be facilitated by the Fed’s decision to continue almost indefinitely buying about US$1tn of government debt annually but the scale of spending envisaged by the Biden administration will require a much greater monetary intervention. The monetary stimulus, which has so strongly boosted asset prices, will continue for some time to come. In the near term the combination of fiscal deficits, aggressive money-printing by the central bank, and the availability of significant savings accumulated during the pandemic, is a formula for strong economic growth. 

The party will come to an end when adverse consequences, probably uncontrollable inflation, force the government to act with more conventional prudence. The restraint imposed by political paralysis would have drawn this process out, extending the longevity of the recovery. Now that the Democrats control the Senate they will spend more and hasten the day when rapidly rising inflation will trigger an awesome financial crisis. 

The lesson from Guareschi

Guareschi wrote about a divided community which could come together to resolve critical issues which affected them all. His message was one of hope and a belief in humanity. Currently it is difficult to see how the United States will develop the comity which will be required to resolve the many problems it will face in coming years. The political divisions seem too great. However, it has in the past faced and surmounted many seemingly insuperable challenges. A study of history provides hope that this will happen again.

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