Opinion

Anatole Kaletsky

Game theory and America’s budget battle

Anatole Kaletsky
Oct 3, 2013 14:17 UTC

So far, the battle of the budget in Washington is playing out roughly as expected. While a government shutdown has theoretically been ordered, nothing much has really happened, all the functions of government deemed essential have continued and financial markets have simply yawned. The only real difference between the tragicomedy now unfolding on Capitol Hill and the scenario outlined here last week has been in timing. I had suggested that the House Republicans would give way almost immediately on the budget, if only to keep some of their powder dry for a second, though equally hopeless, battle over the Treasury debt limit. Instead, it now looks like President Obama may succeed in rolling the two issues into one and forcing the Republicans to capitulate on both simultaneously.

The ultimate outcome of these battles is now clearer than ever. As explained here last week, the Tea Party’s campaign either to defund Obamacare or to sabotage the U.S. economy was doomed by the transformation in political dynamics that resulted from November’s election — above all by the fact that the president never again has to face the voters, while nearly every member of Congress must. This shift in the balance of power made the Republicans’ decision to mount a last stand on Obamacare, instead of attacking the White House on genuine budgetary issues, politically suicidal as well as quixotic. But while the outcome now looks inevitable, the timing of the decisive battle is important. Financial markets and businesses have responded with a tolerance bordering on complacency to the shenanigans in Washington, but this attitude could change abruptly if the House Republicans’ capitulation is delayed too long. As they say in the theater, the only difference between comedy and tragedy is timing.

The risk, as everyone now realizes, is that the battle of the budget — which turns out really to be just a minor tussle over the funding of a limited range of worthy but nonessential government services — remains in a stalemate right up to October 17, when U.S. Treasury is expected to hit its debt limit. At that point, an immediate settlement will be needed or all hell could break loose. The key question for businesses and investors around the world, therefore, is whether the Republicans’ impossible demands to defund Obamacare are removed from the budgetary bills comfortably before the October 17 deadline, or whether this capitulation is triggered by a financial crisis once the deadline draws too close.

Until recently, the Republicans believed October 17 would be their moment of maximum leverage, since President Obama would have no choice but to make concessions or face an economic meltdown. But now it is becoming clear that Republicans will be the ones facing maximum pressure as the debt limit draws near.

Game theory teaches that in such confrontations we must assess the costs to the players of fighting and also of backing down. Republican Congressmen, if they continue fighting right up to the debt limit, will have to answer to voters for the economic mayhem that a Treasury default could cause. Obama, on the other hand, has nothing to fear from elections since he will never run again. The costs of retreat also favor the White House. For the president to back down and gut Obamacare would destroy what he sees as his greatest achievement and would confirm his lame duck status. For the Republicans, by contrast, allowing the budget and debt ceiling to pass would leave them exactly where they were a few weeks ago.

Obama’s best strategy: Do nothing

Anatole Kaletsky
Mar 8, 2013 13:05 UTC

Ronald Reagan had a catchphrase when faced with a crisis, especially a synthetic “crisis” of the kind Washington loves to concoct. He would call in the officials and media advisers rushing manically around the West Wing and calmly tell them: “Don’t just do something – stand there.”  In this respect, as in several others, “No Drama Obama” seems to resemble the man he once admiringly described, despite their ideological animosity, as the last great “transformational” U.S. president.

With Wall Street hitting new records as Washington supposedly plunges into its latest fiscal crisis with the budget sequestration that began this week, Obama could do well to emulate Reagan’s laid-back style. In addition to doing nothing about the latest manufactured fiscal crisis, he could explain why nothing is the right thing to do.

To be more specific, Obama could negotiate a truce in the budget war. Instead of insisting that Republicans must “pay” for Democratic spending cuts by agreeing to higher taxes, the president could offer a much more attractive deal to both sides. If Republicans eased the sequester and demanded no new spending cuts, the Democrats could promise not to raise any taxes. Such a ceasefire would  be seen by both parties as an honorable draw. Republicans would have fulfilled their pledge to stop higher taxes; while Democrats would have thwarted efforts to gut government and the welfare state.

Cooperation isn’t coming to Washington – it’s already arrived

Anatole Kaletsky
Jan 23, 2013 23:50 UTC

The House of Representatives decision to suspend the U.S. Treasury debt limit is the most important political event in America since President Barack Obama was first elected in 2008.  As anticipated in this column immediately after the 2012 election, Washington seems to have broken its addiction to deadly games of economic chicken. That, in turn, should mean an orderly resolution of all U.S. fiscal problems and perhaps even an outbreak of bipartisan political cooperation, at least on economic issues, of a kind not seen in Washington since the early 1990s.

None of these favorable outcomes is yet acknowledged as true in Washington or Wall Street. Political analysts and market pundits have almost unanimously described the House decision as a diversionary tactic, simply designed to shift the high-noon confrontation with Obama to a new battleground more favorable to the Republican side: the March 1 date for automatic spending cuts under the sequestration procedure, or the March 27 expiration date of current government budgets.

This cynicism will almost certainly be proved wrong. The obvious reason is that an army in full retreat, as the Republicans have been since the election and fiscal cliff fiasco, finds it hard to regroup against an enemy enjoying strong momentum. And when such a battered force does attempt a last stand, this usually results in a rout. In this case, however, there are more specific reasons for the Republicans to seek peaceful coexistence instead of the fight-to-the-death over borrowing and spending that many pundits still predict. To see why House leaders decided to unilaterally disarm their nuclear weapons — first the fiscal cliff and now the debt ceiling — one has to understand the transformation in U.S. political dynamics that occurred the moment the votes were counted on Nov. 6.

An optimistic vision of Obama’s second term

Anatole Kaletsky
Nov 7, 2012 21:15 UTC

President Barack Obama’s re-election is good news for the world economy and financial markets. Of course a victory by Mitt Romney, unlikely though it was, might have been even better news, which is perhaps why stock markets fell sharply after the election. If Romney had won, his promised tax cuts and willingness to ignore budget deficits would have delivered a big stimulus to the U.S. economy and triggered a potential boom. But even without this fiscal boost, recent U.S. economic indicators, especially on housing, employment and bank lending, have pointed clearly in the right direction – and now there is every reason to expect these positive trends to accelerate.

While the election was a genuine obstacle to U.S. economic recovery, the problem lay not in the policies of either Obama and Romney but in the uncertainty about whose policies would be implemented and what each party might do to sabotage the other’s plans. This political doubt delayed investment decisions and hiring plans, and, in corporate bank accounts and bond markets, clogged the flood of new money created by the Federal Reserve. Now that the election is over, this dam will start to open. Political polarization, at least on economic issues, will start to ease. And the confrontation over taxes and public spending looming at the end of the year should be resolved with much less rancor than expected. All these optimistic conclusions follow from one crucial feature of the election result: The calculations of self-interest for politicians in Washington, for investors on Wall Street and for business people across America have now been transformed.

Let us begin with the business community. Much of it has been fiercely opposed to President Obama, particularly to his signature policies of universal healthcare and restoring Bill Clinton’s top tax rates. Given that, surveys suggested that many companies, and especially small businesses, suspended normal decisions on hiring and investment for months before the election, while they waited for Obamacare to be abandoned and tax hikes to be ruled out.

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