10/25/12 – Looking Past The Cliff

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Oct 25, 2012 8:57:15 AM

and tagged Fiscal Cliff, Politics and the Economy

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As we move into the last days before the election, both sides have a lot to say on any and every issue that could vaguely be considered relevant. Ever smaller groups of voters are being targeted and pandered to. Today, it’s the “waitress moms,” per the front-page article in the New York Times (NYT), “Crucial Subset: Female Voters Still Deciding.” Obama continues to be the favorite, but at slowly eroding odds. And people are starting to realize that regardless of who wins the election, we are still going to have to deal with the same problems.

The headlines now are focusing more on what we will do, rather than who is going to be doing it. Even as the political uncertainty escalates—the presidential race is getting tighter, and “Number of Competitive Senate Races Rises” on page A6 of the Wall Street Journal (WSJ) points out that control of the Senate may be up for grabs as well—the economic focus is narrowing. Whoever wins, there is a set of problems that will have to be addressed, and those problems are becoming the focus.

The Federal Reserve’s commitment to continued stimulus is a lead story today; it made the front page of the Financial Times (FT), the front business page of the NYT, and page A4 of the WSJ. Clearly, the Fed plans to be there to support whatever action is taken.

The front page of the WSJ has “CEOs Call for Deficit Action,” which states that CEOs are “banding together to pressure Congress to reduce the federal deficit with tax-rate increases as well as spending cuts.” This is a terrific example of the move to the center I discussed yesterday. Business CEOs, at the heart of the Republican coalition—and, not coincidentally, most similar to Romney in background and training—are publicly recognizing that tax increases have to be part of the solution. Read the article; there are lots of quotes that support the fact that taxes will be increasing. There is also great support for Bowles-Simpson.

Indeed, I have said previously that Bowles-Simpson can be read as a reasonable guide to what will eventually happen. Central to that will be not only tax increases, but also tax reform. Tax rates will go down and the tax base will broaden, but tax bills for most people—especially the wealthy—will go up, not down.

At the same time, spending will have to be cut. What I find interesting about the race is that Romney’s economic plan, as best as it can be estimated at this point, is actually very close to Bowles-Simpson on taxes and also provides a plan to cut spending. The Obama alternative relies much more heavily, again as best we can tell, on revenue and does not have a plan to control spending. This has to give Romney an edge in any potential voter’s economic analysis.

The analysis is not clear-cut, though, as the absence of details from both sides leads many to question both plans. One nonpartisan group is under particular attack for an analysis of Romney’s plan, which it deemed not credible, as described in “Tax Policy Center in Spotlight for Its Romney Study” (NYT, p. A4). Nonetheless, the fact that economics is clearly the focus of the race means that whoever wins will have to do something, which could lay the groundwork for serious reform, as laid out in “Election Paves Way for Tax Reform” (WSJ, p. A8).

I continue to believe that the U.S. economy is healing; today’s WSJ headlines on that theme are “New Home Sales Rise 5.7%” and “Supply Boom Upends the Oil Market,” which suggests that oil prices will continue to fall. The major factor holding back a faster recovery is uncertainty. The election will set the stage for resolving the major issue—the size of the federal government’s role going forward and how we pay for that role—and, if so, economic growth may accelerate as companies become more willing to hire and invest.

Here’s hoping.

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