Wednesday, January 27, 2010
On the eve of Obama's first State of the Union address, it's appropriate to update this chart that was first made popular by Jimmy Carter while running for the presidency in 1976. While emphasizing the economic mess that was the legacy of the Nixon and Ford administrations (rising unemployment and rising inflation) likely helped Carter win the '76 election, the Misery Index came back to haunt him by soaring to 22 during the summer of election year 1980. Though not an exact parallel, Obama now faces the wrath of voters as the Misery Index stands at 12.8 (10% unemployment plus 2.8% inflation), its highest level since 1983. This looks especially bad since he promised a year ago that spending $1 trillion in stimulus funds would keep the unemployment rate from rising above 8%.
To make matters worse, today the CBO said that the unemployment rate will likely exceed 10% for the first half of this year and average 10% in the fourth quarter of this year. Meanwhile, by my estimates, the year over year change in the CPI could reach 3.5% by mid-year, and that would combine to push the Misery Index up to almost 14. Not a pretty picture at all.
I'm reminded of Reagan's prescription for taming the miserable Misery Index he inherited: significant marginal tax cuts to boost the economy, and very tight monetary policy to bring inflation down. Obama seems quite unlikely to adopt either of those policy prescriptions, unfortunately. He's promising to freeze non-defense discretionary spending, but that's a mere drop in the almost $4 trillion federal budget bucket. He will probably suggest some tax credits, but those are ineffective at stimulating growth since they aren't permanent and they don't reward increased work and risk-taking. He may offer some tax cuts to small businesses, but how effective they will be remains to be seen. He'll want to spend more money on jobs programs, but that reflects a woeful ignorance of how jobs are created—real jobs are created by the private sector, not by government bureaucrats or spending programs. And with the budget deficit likely to exceed 10% of GDP for the foreseeable future, government borrowing demands can gobble up enormous amounts of credit that could otherwise be used by the private sector for more productive causes.
As for monetary policy, the Fed is sailing in uncharted waters that have the potential to be quite inflationary, but only a handful of folks in Washington are calling for Bernanke to step on the monetary brakes, and not a single Democrat is included in that count.
And thus the year starts with very high stakes at play. I'm counting on the sea-change in the electorate, to judge by the recent Massachusetts vote, to block counterproductive Keynesian spending programs. I'm counting on the economy's inherent dynamism to overcome the adverse headwinds of unproductive government spending programs, as it has done all year long. And I'm counting on all the green shoots and V-signs that I have seen over the past year—signs that the economic fundamentals have improved dramatically and with no help from monetary or fiscal stimulus—to keep economic growth alive, even though unemployment is unlikely to come down meaningfully anytime soon.
One big tailwind I'm counting on is that I think the market is still so worried about a whole host of concerns—another wave of real estate defaults and foreclosures, a dearth of new jobs, another wave of housing defaults, Chinese monetary tightening, a lack of bank lending, huge economic slack (which supposedly threatens deflation), the Fed's inability to reverse its quantitative easing in time—or an unexpected Fed tightening, trillion dollar deficits, the very weak dollar, Obama's increasingly evident inexperience—that any morsel of good news will be a big plus. And despite the constant drumbeat of concerns, we've had a steady diet of good news for many months.
So while there is no shortage of things to worry about, I do see a very significant shift in the political winds. If Obama is going to make any changes to his strategy, they will likely be of the type that is less anti-business and less anti-growth. Even if he doesn't have Bill Clinton's ability to triangulate, Obama today has much less freedom to maneuver on the left. He may feel miserable, but all is not lost from the market's perspective.
Posted by Scott Grannis at 12:37 AM