Opinion

Anatole Kaletsky

The budget deal and Washington’s new politics of compromise

Anatole Kaletsky
Dec 12, 2013 15:16 UTC

The muted market reaction to this week’s budget deal in Washington may initially seem like a disappointment. After all, uncertainty over government spending, debt and taxes has consistently emerged in business sentiment surveys as the biggest single factor holding back corporate investment and damaging financial confidence. Why then did Wall Street celebrate this breakthrough with its biggest daily fall in two months?

The standard explanation is that the budget deal will accelerate the tapering of monetary policy by the Federal Reserve Board, and that is probably a valid expectation. The main reason for the seemingly perverse response, however, is simply that this budget deal was predictable to the point of inevitability, even if most Washington pundits committed to the standard narrative of U.S. political dysfunction and gridlock did not see it coming until this week. Viewed from outside the Beltway, the inevitability of eventual bipartisan cooperation on the budget has been obvious since the 2012 election, which essentially settled all the important U.S. fiscal debates.

Having argued this position all year and having suggested back in October that a deal by this week was very likely, I could hardly be surprised that the markets greeted this event with a yawn. Short-term players on Wall Street have simply followed the time-honored formula of “buy on the rumor, sell on the news.” Business leaders and long-term investors, by contrast, are likely to be relieved and even enthused by this agreement, but their responses will have to be assessed over weeks, months and even years, not just a few days.

There are, however, several important lessons that can be drawn already from the U.S. budget agreement, several with implications for politics and economic policy in other countries. Here, briefly, are five:

1. Political analysts, lobbyists and media pundits whose professional reputations or business models depend on emphasizing or dramatizing political battles often present a misleading picture of economic policies. They naturally tend to exaggerate confrontations and underestimate the possibilities of compromise, even in situations where the interests of all the main political players point towards cooperation, rather than conflict. This principle is as true of monetary policy as of fiscal policy and it applies around the world. For example, European political analysts often exaggerate the confrontations between Germany and other countries or the risks to the euro posed by the German constitutional court or the Bundesbank.

With hostage taking over, a Washington deal beckons

Anatole Kaletsky
Oct 24, 2013 15:37 UTC

Nobody should be surprised that Wall Street hit new records this week. After all, the U.S. has just witnessed the end of a sensational hostage crisis that was threatening national security and undermining economic confidence — and even more sensationally, this was the second such crisis in two months.

John Boehner was held hostage by Republican hardliners until last Thursday, when the U.S. Congress voted to continue pumping money into the U.S. government. The fiscal militants forced Boehner to endanger the U.S. economy with threats of a Treasury default. Boehner reluctantly paid this rhetorical ransom in order to preserve the appearance of party unity and therefore his own credibility as a political leader.

Now consider events a month earlier on the other side of Washington. Until September 18, when the Federal Reserve voted to continue pumping money into the U.S. bond market, Ben Bernanke was arguably held hostage by the Fed’s hardliners. The monetary militants forced Bernanke to endanger the U.S. economic recovery with threats of a premature end to quantitative easing. Bernanke reluctantly paid this rhetorical ransom in order to preserve the appearance of institutional unity and therefore his own credibility as an economic leader.

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.

Why markets don’t fear a government shutdown

Anatole Kaletsky
Sep 26, 2013 14:44 UTC

Now that the worldwide panic over U.S. monetary policy has subsided, Washington is brewing another storm in a teacup: the budget and Obamacare battle that reaches a climax next Monday, followed by the debt limit vote required to prevent a mid-October Treasury default. The ultimate outcome of these crises is a foregone conclusion. As Senator John McCain told the press this week: “We will end up not shutting down the government and not de-funding Obamacare.” He could surely have added that a Treasury default is also out of the question.

But how exactly will Washington manage to dodge these bullets? As McCain added, “I don’t know what all the scenes are, [although] I’ve seen how this movie ends.” Markets understandably fear that all the plot twists leading up to a seemingly satisfactory resolution could produce an economic horror film, crushing business and consumer confidence, damaging economic growth and triggering a major sell-off in global stock markets. That, after all, is exactly what happened when the U.S. Treasury almost defaulted in July 2011.

What, then, are the chances of similar disruption in the weeks ahead? The risks this time are much smaller than in 2011 because of four events that have transformed the dynamics of U.S. budget battles.

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