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Archive for March, 2012

ELECTION YEAR POLITICS

AND THE ECONOMY

 [Part I]

 

By far the most important question the voters must grapple with this coming fall presidential election is: Who best can lead the country the next four years toward greater prosperity and less unemployment? To answer that question will require that you put forth your best effort to become an informed, knowledgeable voter. I’m here to help you.

To help you in this process, I am initiating a SIX part series on Election Year Politics and the Economy. At the top just let me say that the only general tools the government has to influence the economy is known as Fiscal Policy and Monetary Policy. Generally, the President has discretionary influence over fiscal policy, and the Federal Reserve, an independent government agency, sets monetary policy.

Part I of this series will provide a description of the context for the coming fall presidential election, and provide knowledge on a very unique theory—The Presidential Election Cycle Theory.

Part II will provide an explanation of economic cycles and how they work, and provide explanations on the American economy and fiscal policy.

Part III will provide an explanation of how President Obama views fiscal policy.

Part IV will describe the American economy and monetary policy.

Part V will describe the accomplishments of President Obama during his first term in office.

Part VI will describe the accomplishments of the Republican Party.

This Blog will end with a summary that brings it all together, and I will tender a suggestion as to who I think should become President of the United States in November, 2012.

 

Context of the Fall Presidential Election

This coming presidential election in November 2012 will be one of the most provocative in recent political history. Why? Because our most critical domestic issue this coming election is the economy, something that impacts everyone’s pocketbook. And, since the economy impacts everyone’s pocketbook it is deemed the most important issue facing the American people.

Unfortunately, all of the political rhetoric, distortions, name-calling, and bombast on television or radio, tend to obscure the economic issue and all facts attendant to it. This leaves the American voting public in a quandary. Does one vote to re-elect the President or not?

Politicians on both sides of the aisle are very skilled at creating non-factual arguments because they don’t necessarily want clarity in addressing the economic issue or any other. Since survival is the name of the game in Washington, all politicians want to do is speak about values and generalities in order to promote the exclusivity of one’s own political party, personal survival, and ideology.

As we all know, once someone has been elected they tend to do what they want anyway and have a short memory for promises made. Of all our previous presidents I think it is fair to point out that President Obama has made a good faith effort to achieve what he set out to do when he made campaign promises while running for the presidency in 2008. One could argue that Barrack Obama, along with Thomas Jefferson, Woodrow Wilson, and Richard Nixon were the smartest most highly intelligent Presidents ever to occupy the White House [As an aside, John Adams was no slouch either where intelligence is concerned ]. However, being really smart does not necessarily mean one is the most effective in making things happen. You want bright people in the White House but you also want them to be effective and honestly meet the needs of the general electorate.

After reading Part’s V and VI you will have to decide whether the accomplishments of President Obama measure up (or not) to those of the Republicans during his term in office. I recommend you give strong weight in your voting decision based on actual accomplishments, not expressed or implied values, or campaign rhetoric.

It is obvious every election cycle that the public (whatever the issues are) is pretty much on its own in the whole process of fact-finding. Ever sit on a jury? If you have you know the jury’s responsibility is to do its own fact-finding, and to assess the preponderance of the evidence (or beyond a reasonable doubt) in a particular type of case. In a sense political campaigns are like jury trials. Everybody tries to make their case and then the voters retire to render their verdict. Such a verdict will unquestionably be given this coming fall presidential election.

Where this coming election is concerned, it means it is up to you to make an informed decision and take responsibility for that voting decision by becoming more knowledgeable as to how the economy really works, and to obtain those elusive facts politicians would rather dodge in a campaign.

Let me say up front that this can be a daunting task before you. Even economic experts and pundits disagree on this subject all the time. This added state of disagreement, even among the experts, pretty much confounds a voter’s ability to make a sound decision as to who should lead the charge the next four years to achieve greater prosperity and near full employment. In such a situation like voter obscuration or expert disagreements, the average voter can only scratch his head in utter confusion.

If you wish to make your voting decision this fall based on criteria like the candidate has a nice personality, or is good-looking, or you just want change come hell or high water, than don’t bother reading this Blog. If however, you want to be a good citizen and make the most intelligent, highly informed, data-driven decision you possibly can—then I recommend you read on.

Eight Areas of Importance

In our search to figure out who our next president should be come November, 2012—it is essential that you acquire an understanding of how the economy does in fact work, and its connection to politics, whatever the real level of influence politics can exert on the economy. To do this—one needs to be aware of eight areas of knowledge. And, this is the knowledge you will need: 

 

  • Context of the Fall Presidential Election
  • The Presidential Election Cycle Theory
  • Economic Cycles and How They Work
  • The American Economy and Fiscal Policy
  • How the President Views Fiscal Policy
  • The American Economy and Monetary Policy
  • The Accomplishments of President Barack Obama
  • The Accomplishments of the Republican Party

If you can acquire (and remember) the details from the above eight areas, you will be on solid ground to be able to cast that all-important vote this coming fall. Good luck in your efforts!

 

In my humble opinion, the collective knowledge gained in this crash course should sufficiently help when you cast your vote this fall. All of this knowledge, of course, gives you the ammunition. But, will such knowledge extricate you from your own biases? Probably not, because the very values that make you who you are—are exactly the same values politicians want to exploit so they appeal to the largest number of voters.

Values serve as a kind of ship’s keel as you make your way through choppy and uncertain economic waters. While values will ultimately persuade you in critical decision-making as to how to vote this fall, knowledge and facts should serve to set a proper guiding course. That is, knowledge and facts should tell you whether the country is headed in the right direction. What is the right direction for the country? Well, here is a clue to that question.

Economic cycles are predictable as to telling us whether the GDP will be expanding or contracting. The difficulty lies in knowing precisely when we as a nation are beginning to climb up that expansionary curve so often associated with prosperity and higher than normal employment levels. But there are socially relevant tradeoffs that occur in every type of cycle. It does appear that the economy, at this time, has turned a positive corner. But beware. One of the tradeoffs to occur along with a positive growing economy is the specter of everyone’s nemesis or enemy—known as inflation.

A Values Framework

Human emotions, intellect, and values play major roles in all types of human behavior—including decision-making. Collectively, they are all explanations for human behavior. Sociologists might argue that the order of importance of these explanations, where making tough political decisions are concerned, is determined first and foremost by values.

For the sake of argument let’s say the sociologists are right. If they are right here is one scenario that might explain voter behavior in an election. The goal politicians have is to inspire as many voters as they can into believing that their values are the same as the values of the candidate. They do this by infusing their message to the voter with a sufficient number of lofty “value-oriented buzz words.” By promoting values rather than facts, data, or pragmatic solutions (although they often speak of solutions in obscure generalities) they hope to corral each voter and enlist their loyalty through identification with expressed values.

Politicians are not only bright—they’ve also got your number. They know first hand that most voters hold certain values that are reinforced on an emotional level, not on an intellectual level. All I can say is—don’t let them run rough shod over you. Surprise them this time—go armed with factual knowledge—and make it a regular part of your thinking process. Values are important—no doubt about it. But don’t ever give a back seat to intelligent thinking supported by facts and knowledge. What good are values if you elect a “Bozo the Clown” to the White House?

 

The Presidential Election Cycle Theory

 

Another interesting way of looking at the economy and business cycles is based on knowing their relationship to political decisions. The partisan business cycle suggests that cycles result from the successive elections of administrations with different policy regimes. Regime A adopts expansionary policies, resulting in growth and inflation, but is voted out of office when inflation becomes unacceptably high. The replacement, Regime B, adopts contractionary policies reducing inflation and growth, and the downwards swing of the cycle. It is voted out of office when unemployment is too high, being replaced by Party A.

The political business cycle is an alternative theory stating that when an administration of any hue is elected, it initially adopts a contractionary policy to reduce inflation and gain a reputation for economic competence. It then adopts an expansionary policy in the lead up to the next election, hoping to achieve simultaneously low inflation and unemployment on election day. This did not occur with the George Walker Bush administration causing President Obama to inherit a severe contractionary recession when he first took office. This, in theory, was contrary to what the election cycle theory would have predicted. Later in this section the caveats to this theory will be described.

The political business cycle theory is strongly linked to the name of Michael Kaleck who argued that no democratic government under capitalism would allow a recession to be created by political decisions. Persistent full employment would mean increasing workers’ bargaining power to raise wages and to avoid doing unpaid labor, potentially hurting profitability. Kaleck did not see this theory as applying under fascism, which would use direct force to destroy labor’s power.

In recent years, proponents of the “electoral business cycle” theory have argued that incumbent politicians encourage prosperity before elections in order to ensure re-election—and make the citizens pay for it with recessions afterwards.

Policy with the Presidential Election Cycle Theory

The active pursuit of national full employment through interventionist government policies is associated with Keynesian economics and marked the postwar agenda of many Western nations, until the stagflation of the 1970s.

Australia

Australia was the first country in the world where full employment in a free society was made official policy by its government. On May 30, 1945, The Australian Labor Party Prime Minister John Curtin and his Employment Minister John Detman proposed a white paper in the Australian House of Representatives titled Full Employment in Australia, the first time any government apart from totalitarian regimes had unequivocally committed itself to providing work for any person who was willing and able to work. Conditions of full employment lasted in Australia from 1941 to 1975. This had been preceded by the Harvester Judgment (1907), establishing the basic wage (a living wage); while this earlier case was overturned, it remained influential.

United States

The United States is, as a statutory matter, committed to full employment (defined as 3% unemployment for persons 20 and older, and 4% for persons aged 16 and over). The government is empowered to effect this goal, and a job is a right. The relevant legislation is the Employment Act (1946), initially “Full Employment Act”, later amended in the Full Employment and balanced Growth Act (1978).

The 1946 act was passed in the aftermath of World War II, when it was feared that demobilization would result in a depression, as it had following World War I in the Depression of 1920-21, while the 1978 act was passed following the 1973-75 recession and in the midst of continuing high inflation.

The law states that full employment is one of four economic goals, in concert with growth in production, price stability, and balance of trade and budget, and that the US shall rely primarily on private enterprise to achieve these goals. Specifically, the act once again is committed to an unemployment rate of no more than 3% for persons aged 20 or over and not more than 4% for persons aged 16 or over (from 1983 onwards), and the Act expressly allows (but does not require) the government to create a “reservoir of public employment” to effect this level of employment. These jobs are required to be in the lower ranges of skill and pay so as to not draw the workforce away from the private sector.

However, since the passage of this act in 1978 (for 33 years now during several deomocrat and republican administrations I might point out), the US has, as of 2011, never achieved this level of employment, nor has such a reservoir of public employment been created.

Job Guarantee

Some, particularly Post-Keynesian economists have suggested ensuring full employment via a job guarantee program. This would mean that those who are unable to find work in the private sector would be otherwise employed by the government. Such employed public sector workers would fulfill the same function as the unemployed do when they help to control inflation, but without the human costs of unemployment.

Parenthetically, I bet many of you reading my Blog didn’t realize that having a large pool of unemployed people actually helps keep prices lower or at least stable. Sad but true. Absolute full employment, while being desirable in a social context, or as a goal of society, nevertheless fuels higher prices. Full employment creates greater demand for additional goods and services. When demand increases what do prices do? You guesses it! Prices increase in order to help supply keep pace with demand.

It may be that one of the factors right now creating higher gas prices, is a rebounding of our economy. Democrats probably hate this economic fact, and republicans would prefer to hide this economic fact. At the moment an added feature of the 2012 presidential campaign is that the Republicans blame the Democrats for higher gas prices even though it’s due to the success of the Obama administration, not its failure. The economy and the job creation plans of the president are now finally going into second gear. Said another way, higher gas prices may reflect the fact that our economy is coming back from a severe recession and is now improving every day. Conspiracy theorists would argue for other explanations having to do with oil companies, the stock market and special interests. However, oil companies, the stock market and special interests have been with us during times of high and low prices for gasoline. I don’t have all the answers here but my guess is that the best explanation is still an economic one. However, having said that, it is clear that global factors like where we obtain our oil does affect pricing. Nevertheless, regardless of what causes interruptions in the accesibility of oil (thus gasoline prices later on) supply and demand as economic forces still dominate what happens at the pump.

The Stock Market and the White House

Do you think who you vote for president will in any way affect the economy? According to the presidential election cycle theory, it may not make a difference. History suggests that the stock market and the four-year presidential election cycle follow strong, predictable patterns.

So, whether you’re voting Democrat, Republican or some third party candidate, find out what these patterns can tell you about the stock market – and perhaps even the next presidential race. One critical question is—is it better for the stock market to have a Democrat president in the White House or a Republican?

The presidential election cycle theory, which was developed by Yale Hirsch, is based on historical observations that the stock market follows, on average, a four-year pattern that corresponds to the four-year election cycle. The theory suggests that on average, the stock market has performed in the following manner in each of the four years a president is in office:

Year 1: The Post-Election Year


The first year of a presidency is characterized by relatively weak performance in the stock market. Of the four years in a presidential cycle, the first-year performance of the stock market, on average, is the worst.

Year 2: The Midterm Election Year
The second year, although better than the first, is also is noted for below-average performance. Bear market bottoms occur in the second year more often than in any other year. The Stock Traders Almanac (2005), by Jeffrey A. and Yale Hirsch, note that “wars, recessions and bear markets tend to start or occur in the first half of the term.”

Year 3: The Pre-Presidential Election Year
The third year, or the year just before the election year, is the strongest on average of the four years.

Year 4: The Election Year
In the fourth year of the presidential term and the election year, the stock market’s performance tends to be above average (If you’ll notice it’s now nearly back to its all time highs).

Stock Market Return by U.S Presidential Term Year

1948-2008

 

Year Average Annual Return
1 7.41%
2 10.21%
3 22.34%
4 9.79%

 

Source: S&P 500 Total Return Index

Although the numbers will change somewhat depending on the exact time frame used, the basic pattern has persisted – a weak first half and a strong second half of the presidential term.

 

Statistical Confidence and Conclusions Drawn
One of the problems with drawing conclusions from the presidential election cycle is that the theory is based on relatively few observations. Since 1900, there have been only 27 presidential cycles up to 2008. Many of the studies done on the theory are based on even fewer observations.

For example, since 1948 there have been only 15 different terms – when it comes to statistics, this is a very small sample, which makes it difficult to draw accurate conclusions, even without considering the inherent limitations of correlations in the first place (like attributing causation to spurious correlations).

As such, the theory could be attributed to data mining. In other words, if people are constantly looking at enough data for specific patterns, patterns can emerge, even if there is no real significance to them.

Other Spurious Correlations

An example of this is the Super Bowl Indicator which has shown to be a reasonably good measure in forecasting the market. According to this indicator, when an “original” team from the National Football League (NFL) wins the Super Bowl, the Dow Jones Industrial Average (DJIA) will rise in the following year. However, when a team from the American Football League (AFL) wins, the market is predicted to fall. By some estimates, the Super Bowl indicator has predicted the DJIA trend correctly in 35 out of 44 years.

The problem, of course, is twofold with these kinds of indicators. First, there is no logical theory to explain cause and effect. In other words, why would a sporting event have any relationship to the stock market? That is, there is no logical connection between the two. It’s a lot like attributing the cause of earthly or human events to invisible unquantifiable supernaturalism where the cause is alleged to be a sky God that judges you. There is simply no proof or measurement of either God, or His alleged effect on earthly or human events.

Second, the stock market follows cycles where many of the variables interact with each other, i.e., where every variable affects every other variable to some degree and vice-versa. Even the most sophisticated statistical models cannot show cause and effect, only mathematical theory-based correlations. I could take time to explain to you what a “convergence of the evidence” means statistically, but that is far and above what this Blog is all about. Suffice it to say what scientific thinking and analysis look for is agreement across many studies producing a convergence of the evidence. While economic principles are on solid ground, not every study suggesting cause and effect between variables can control external variables outside one’s statistical model. For now, let’s just continue with our crash course.

Academic Studies

Although the Super Bowl indicator is a statistical oddity, the presidential election cycle theory appears to have some basis to it. It has been the subject of many academic studies that have attempted to prove or disprove it and to understand the reasons behind it. Most studies support the evidence of a significant relationship between the presidential cycle and the stock market. Since political actions can influence the stock market and such a theory has received support from the data that has been collected and analyzed.

A study published by the National University of Singapore in January 2007 entitled “Mapping the Presidential Election Cycle in the U.S. Stock Market” by Wing-Keung Wong and Michael McAleer found that, “there were statistically significant presidential election cycles in the U.S. stock market during the greater part of the last four decades … stock prices decreased by a significant amount in the second year and then increased by a statistically significant amount in the third year of the presidential election cycle.”

The relationship between the presidential election cycle and the stock market makes sense – the president has considerable (however, it is debatable) impact on the economy through his policies and actions. For example, many people credit the tax cuts that President George W. Bush championed in 2003 for boosting economic activity and improving stock market performance.

Can Stock Markets Pick Presidents?

Most studies on the presidential election cycle look at the relationship the presidential cycle has on stock prices. However, rather than the election cycle predicting a trend in stock prices, maybe the trend in the stock market can predict who will be elected president.

In a study done by John Nofsinger, “The Stock Market and Political Cycles,” which was published in The Journal of Socio-Economics in 2007, Nofsinger proposed that the stock market can predict which candidate will be elected.

He analyzed the relationship between the social mood of the country and the presidential election and concluded that when the country is optimistic about the future, the stock market tends to be high and voters are more likely to vote for those in power. When the social mood is pessimistic, the market is low and people tend to vote out the incumbent and put a new party in power.

According to Nofsinger’s research, the stock market returns in the three years prior to the election is useful in predicting whether the incumbent party candidate will be elected or whether there will be a new party in power at the White House.

Republican versus Democrat Presidents

Although Republicans are generally considered to be more pro business than democrats, studies suggest that when a Democratic president is in the White House, it may be generally better for the stock market.

A research study called “The Presidential Puzzle: Political Cycles and the Stock Market” (2003) done by Pedro Santa Clara and Rossen Valkanof of the University of California, Los Angeles, demonstrated that the stock market performs better under Democratic presidents. Using data from 1927 to 2003, they found that the excess returns have been about 2% for Republican presidents, but 11% for Democratic presidents. Among small cap stocks, the difference is even greater. The bottom 10% of stocks as measured by market cap showed a difference of excess returns of about 22% for Democrats compared to when a Republican held the presidential office.

Furthermore, on average, the stock market volatility during a Republican administration was more pronounced than that during a Democratic administration.

Market Bottoms and the Presidential Cycle
Stock market cycles are well documented, with alternating bear and bull markets. When those cycles are superimposed over the election cycle, it is found that market bottoms tend to occur in the first term of a presidency.

In his study “Presidential Election and Stock Market Cycles,” Marshall Nickels of Pepperdine University analyzed stock market bottoms in relation to the presidential cycle. In the period from 1942 to 2006, there were 16 presidential terms and 16 market lows corresponding to those terms.

Three of the lows occurred in the first year of the presidential term, 12 in the second year, one in the third year, and none in the fourth. Of the 16 bottoms, 15 occurred in the first half of the term and only one in the second half of the term.

Rationale for the Presidential Election Cycle

Politicians are very astute when it comes to getting re-elected – if there is a relationship between voter approval and the state of the economy, you can bet they will capitalize on it. One of the assumptions that explain presidential elections cycle theory is the rather cynical view that many of the policies that come out of the White House and elected government officials in general are done with the primary goal of getting elected and re-elected. The impact on the economy is a secondary consideration. Policies are motivated to keep the existing political party and its representatives in power.

In the first term after the election, presidents tend to focus on campaign promises and push through tougher legislation related to tax increases, government spending cuts etc. They push for policies that are more restrictive or disruptive and that might slow down the economy. By doing the unpopular things early, they hope that the electorate will forget about them by the time the next election rolls around.

In the second year of the term, the president may use fiscal stimulus, such as tax cuts or increases in government spending. The belief is that the people will feel better and therefore be more likely to elect that president or his party again. In the time leading up to an election, the pre-election campaign promises often create a mood of optimism among voter and investors alike.

In Part II ahead of this Blog I will explain how economic cycles work as well as the American economy and fiscal policy.

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