NEXT WEEK America will undergo its biggest political upheaval in six years. The monopoly of power enjoyed by President Bush’s Republicans is almost certain to be broken in the midterm congressional election on Tuesday. The latest opinion polls suggest that the Democrats will definitely take control of the House of Representatives, while the chances of the Senate also changing hands are slightly below 50-50, since only one third of Senate seats are up for re-election. George W. Bush will, of course, remain President, although there is some talk among Democratic hotheads about launching impeachment proceedings over the war in Iraq if they should win control of both houses of Congress.
Since this is a column about economics, rather than politics, we can leave such speculation to one side. Instead let us consider the impact a swing in the US political pendulum could have on the world economy and the financial markets.
The reflex reaction among investors and businessmen is to assume that a big defeat for the Republicans would be bad news for the world economy, the stock markets and the dollar. At best, it would lead to a period of political gridlock, paralysing decisions in Washington on important issues such as fiscal policy, corporate regulation and world trade. At worst, it would push US politics in an anti-business direction.
Democrats instinctively would want to raise taxes, increase public spending, tighten the already stifling regulations on Wall Street, campaign for protectionism, strengthen trade unions and directly attack industries that have long been unpopular with the American Left — for example, health insurance, banking, pharmaceuticals and oil. At a time when the US economy is palpably getting weaker, while inflationary pressures remain quite intense, a combination of higher, stronger wage pressures and greater regulation would seem to pose a serious threat.
Yet this commonplace analysis of a Democratic victory is likely to prove wrong on all counts. In my view, a Democratic victory will have no effect on US economic performance, will probably be bullish for most equities and potentially very positive for the dollar.
Why? Let us start with macroeconomics. In terms of fiscal policy, the election will lead to legislative gridlock, but this should be seen as a positive result. The Democrats will be able to block new initiatives from the White House on tax cuts, but they will not have enough votes actually to introduce new spending bills over President Bush’s veto, or to raise taxes. As a result, US fiscal policy will remain exactly where it is today — and that is about where it should be. The conventional wisdom a few years ago about the terrible dangers posed to the world economy by America’s “twin deficits” has turned out to be quite wrong and a do-nothing approach to fiscal policy, allowing US budget deficits and public debt levels to stabilise at around their present levels, looks about right for the next few years.
What about global trade? The Democrats are ideologically more protectionist than the Republicans, but this is mitigated by the geographic concentration of the two parties’ support. The South and West of America, where Republicans attract most of their votes, is also the heartland of American protectionism. The Democrats tend to represent the East and West coasts, where voters are more liberal and cosmopolitan, so that a Democratic victory could actually increase the influence in Washington of the liberal economic establishment. In any case, President Bush’s “fast-track” authority to negotiate a global trade agreement expires next July and he has almost no chance of an extension. Thus, whatever happens next Tuesday, a global trade deal is not going to happen before the next president is in office in 2009.
Turning to particular industries and sectors, fears about a Democratic victory also seem overblown. Even in the unlikely event that the Democrats take both houses of Congress, they will immediately start fighting among themselves as potential candidates for the 2008 presidential election jockey for position. Under these circumstances, it is unlikely that a consensus could be created to attack industries with substantial lobbying power and financial clout.
The one important exception may be oil. An energy tax, offset by increased benefits and tax credits for low-income families, appears to be an idea whose time has come. Even those Americans who care little about climate change now see the concentration of energy resources in potentially hostile Islamic countries as one of the greatest threats to their long-term security. Several state legislatures have introduced emissions limits and carbon-trading mechanisms and last week Greg Mankiw, Mr Bush’s former chief economist, came out in favour of a comprehensive carbon tax. The only insuperable obstacle is now the President himself. Thus a vote of no confidence in Mr Bush could put the prospect of an energy tax on the political agenda, even though nothing could actually happen while he remains in power. If that were to happen, it would, presumably, be bearish for most oil shares and also for US manufacturers of gas-guzzling vehicles. But America’s willingness to embrace European-style energy taxation would be very bullish for most non-oil assets around the world — and also probably for the dollar.
Non-oil assets around the world would benefit because any serious prospect of the sort of vast reduction in American oil consumption that would result from an energy or carbon tax, would dramatically shift the balance of global supply and demand. Oil prices easily could fall to $30 a barrel or lower if America seemed serious about a carbon tax. A US energy tax would shift hundreds of billions of dollars in monopoly rents from oil-producing countries to the US Government. If US carbon tax revenues were offset by cuts in other US taxes, as they surely would be for such a plan to be politically acceptable, Opec’s loss would translate into an equivalent gain for American consumers — and the businesses that they support.
The dollar’s connection with oil and American foreign policy is even more straightforward. The bear market in the dollar began on the very day that Mr Bush delivered his Axis of Evil speech on January 29, 2002. The dollar has been falling ever since, partly because it has dissipated US military power, but mainly because the Axis of Evil policy has raised the price of oil and thus perversely handed vast new wealth to oil-producing countries inherently hostile to America and reluctant to invest in dollar assets. The dollar will surely gain if American voters signal in next week’s election that this self-destructive policy must now be ended.
