Article / 05 November 2014 at 14:58 GMT

The Democrats, the Republicans and the economy

Managing Partner / Spotlight Group
United Kingdom
  • Republicans seize Congress, Senate
  • US economy performing well relative to EU
  • Renewed debt battle could paralyse US business

By Stephen Pope

The 2014 midterm elections in the US have handed control of both Congress and the Senate to the Republicans. This places the direction of these two chambers at odds with the Obama White House, a development that could have far-ranging implications for the economy over the next two years.

Looking at a set of key economic data points, one might wonder why the electorate have turned against the Democrats so aggressively. For example, let us compare several important metrics for the US with their equivalents in that other, similarly sized free-market democratic bloc — the Eurozone.

US/EU comparison

Source: US Department of the Treasury, US Bureau of Labor, Federal Reserve, Eurostat

(The scale of the chart above would be rendered useless if I had added unemployment rates; the latest measures, however, are 5.9% for the US and 11.5% in the Eurozone.)

The chart above is favourable regarding the US' economic outlook. By every metric represented, America is doing better than is Europe’s single currency region. So why did Obama's Democrats fare so badly in yesterday’s polling?

As the year developed, it appeared as if any one of a number of sensitive issues could have become a backdrop to the midterms. Obamacare, scandals at the Veteran’s Affairs Department or even the level of US engagement in the Middle East... there were multiple "lightning rods" for ambient dissatisfaction. Still, none of these issues seem to have been the key debating point. 

The real issue appears to be one of deep frustration with the Obama administration. Relative to this diffuse concern, worries about the economy have faded into the background. The issue here is that most voters know that the president has, since he took office in January 2009, been impeded by a far-right element that opposed every item of his agenda.

Obama

President Barack Obama's approval rating has hit record lows. Photo: Joe Raedle \ Getty

The electorate are angered by what they see as Capitol Hill brinksmanship. They are distressed by the sort of games that almost saw the US default on its debt, and their frustration is a general one, and aimed at all politicians. 

That said, it is usually the case that the buck stops at the top. As such, it is the party that controls the White House that tends to fare the worst in such climates.

Economy at risk

As the Republicans have captured the Senate with a narrow majority, there is a chance that this is will lead toward another standoff over taxes and spending. In the past, this kind of "DC gridlock" has destabilised consumer confidence, the stock market and job creation.

We now have to ponder how the Republicans will direct the course of the Senate. There has been little in the way of hard detail from any Senatorial contender and so we have to speculate if Senate Republicans will repeat past budgetary clashes with renewed energy. 

As an alternative, the Grand Old Party may prefer to take a long view toward the White House in 2016 by chasing smaller deals on less contentious issues with President Obama. 

What is clear is that Senate leader-elect Mitch McConnell (Rep-Kentucky) knows that in two years’ time, it could be the public’s view of his record that will shape the mood of the presidential campaign — regardless of who is nominated by both parties.

Mitch McConnell

McConnell 's campaign focussed on his ability to broker deals 
between Democrats and Republicans. Photo: Mark Wilson \ Getty

If Washington descends into another default-threatening battle over the budget and debt ceiling, the uncertainty is likely to paralyse businesses and consumers. However, one would be right to be wary of cobbled-together schemes. In the past, hasty agreements fettered the economy as taxes had to be raised and funds for military and social programs (that can often boost the economy) were cut.

Settlements brokered to end clashes in 2011 and 2013 did manage to cut the budget deficit, but they have reduced gross domestic product growth over the past three years (according to data from the Department of Commerce). Automatic spending cuts that were approved in 2011 led government spending to fall as a proportion of the national GDP, and two years later higher tax rates also slowed growth.

GDP growth has been tepid to where it could have been, but that opens a European-style debate over austerity versus stimulus. Even given the dollar's status as reserve currency of the world, the US cannot keep piling up more and more debt through increased borrowing, especially when the Fed is no longer in the business of acquiring Treasury assets.

In March 2015, the new-look Congress must find a path to fund the government and vote on whether to raise or suspend the debt limit. The 2011 battle over a debt ceiling increase caused financial markets to plunge and triggered the first-ever first downgrade in the US credit rating by Standard and Poor's. 

At the time, several economists warned of the threat of another recession. That did not materialise, but the agreement to raise the government's borrowing authority mandated spending cuts be implemented through 2021.

Taxation is another problem that awaits the political elite in DC. The economy was wobbling when temporary cuts to income tax rates were on the verge of expiring last year. 

Still, these confrontations are not holding things back for the moment. Futures are up, the major indices are soaring and the S&P 500 looks set to approach another new record!

-- Edited by Michael McKenna

Stephen Pope is managing partner at Spotlight Ideas. Post a comment below or follow Stephen to engage with Saxo Bank's social trading platform.

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