Be prepared for US political cliff dancing
By Gillian Tett
A decade ago, economists sometimes like to say, the west was experiencing an era of “Great Moderation”; at least, in the sense that inflation was tame, central bankers looked wise and economic growth assured. Then, when the financial crisis erupted, moderation was replaced by an Age of Turbulence (to use the ironically apt title of Alan Greenspan’s memoir).
But now we have entered a third phase: an era of political brinkmanship. In the aftermath of President Barack Obama’s victory on Tuesday, there is intense speculation among investors about whether America will fall off a fiscal cliff at the end of the year, as it hits the trifecta of a debt ceiling, the expiry of Bush-era tax cuts and pre-planned spending cuts, which could reduce gross domestic product by 4 per cent.
But what probably looms now is not a simple, binary “fall” – or a grandiose bargain to avert that blow – but a series of rolling showdowns. In the coming months, politicians may tiptoe to the brink of the cliff; they may even spark some mini-crises, by failing to cut a deal before, say, the debt ceiling expires, or tax rises loom. But I suspect they will then tiptoe back from disaster, with delaying mechanisms, before embarking on yet more brinkmanship. This game of cliff-dancing could last a long time.
Some senior Obama officials strongly reject this scenario. After all, they argue, the results from Tuesday’s election should give the president confidence to force a grand fiscal deal, particularly since he has less incentive to appease voters in his second (final) term and the Republicans are on the back foot. Second, since politicians have now been arguing about fiscal issues for more than two years, which means the terms have been laid out.
Thus there is no need to fret about the President’s failure to back the 2010 Simpson-Bowles bipartisan plan for tax rises and spending cuts, optimists insist; what matters is that this scheme exists as a starting point for debate, and that will accelerate the negotiation process.
Thirdly: dozens of American business leaders are now – belatedly – speaking up, along with the Federal Reserve, and pushing for a grand fiscal deal, be that via the Simpson-Bowles plan or something similar. That should also raise the chance that Mr Obama will deliver a grand bargain. Or so the argument goes.
But those reasons for hope are also offset by at least three concerns. One, immediate doubt is whether Republicans will co-operate in serious talks. For though John Boehner, House Speaker, has indicated in the past 24 hours that he is willing to discuss tax increases, he faces strident opposition from his party to this. Secondly, even if business leaders are raising pressure for a grand fiscal deal, there is still no dramatic external event that could shock both political camps into compromise.
This matters. Congress only agreed to back the financial rescue programme in 2008 after the markets crashed. But now the markets are extraordinarily quiet, partly due to the Federal Reserve’s policies; indeed, the 10-year Treasury yield has actually dropped this week. And dire warnings from rating agencies – or even the International Monetary Fund – have lost some of their ability to shock. Unless America does fall off that “cliff”, the sense of drama may stay distinctly muted.
There is also a more subtle, structural problem: a mismatch in time horizons. As Claudio Borio of the Bank for International Settlements observed in a recent speech, credit booms and busts occur on multi-decade cycles, and require equally long-term policies; however, the effective US political cycle is two years. “The economic developments that really matter now take much longer to unfold – economic time has slowed down relative to calendar time – and yet the planning horizons of economic agents have shortened.”
This is pernicious. Any package that truly works will need two crucial elements: clearly articulated, proactive long-term fiscal trade-offs, and an intelligent sequencing of policies (say, some stimulus followed by austerity). Delivering this will be hard.
None of this is a reason to despair. The “good” news is that investors have had plenty of chance to get used to cliff dancing in the past year – on both sides of the Atlantic. Dramatic headlines about disaster might sap confidence, but they do at least cause less shock than a decade ago, and thus may spark less sudden market reaction. But then again, precisely because markets have become more wearily blasé about brinkmanship, it may be that much harder to create the sense of drama to force an early bipartisan political deal.
Unless, of course, Mr Obama finds the capacity to spring another bold surprise, or politicians and investors alike finally – belatedly – lose patience, and that Age of Turbulence once again takes hold.
gillian.tett@ft.com
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