Sat 15 Nov 2008 07:34
Why markets are predicting apocalypse
According to the University of Iowa’s presidential-futures market, John McCain’s prospects peaked on March 22, 2008. By that day it was clear he’d be the nominee, though he had not yet been officially nominated. The market implied that his odds of winning the White House were 55 percent.
But then financial markets began their historic fall, which accelerated as the campaign wore on. When McCain’s probability of winning was at its peak, the S&P 500 index stood at 1,329.54. By November 5, it had dropped 28.3 percent, to 952.77. The question: Did the tanking economy help Obama; did the economy tank as a reaction to the fact that Obama might become president; neither; or both?
Democratic partisans prefer the first explanation. Nobel Prize–winning economist Joseph Stiglitz, for example, recently wrote that “Barack Obama owes his victory in large measure to the prospect of the longest and deepest economic downturn in a quarter-century and perhaps since the Great Depression.”
Stiglitz is right. The link between bad economic news and diminishing prospects for the presidential candidate who represents the incumbent party is older than sliced bread, and has been carefully documented by Yale economist Ray Fair. But Stiglitz is only half right, because the negative correlation between Obama’s prospects and stock prices reflected an ominous feedback loop: As Obama’s odds of winning rose, markets tanked; as they tanked, Obama’s odds of winning rose.
Obama supporters will of course dispute this, but market movements after the election confirm that an “Obama Panic” took place in October and November. The day after the election, the S&P 500 dropped 5.2 percent, the worst reception ever for a winning candidate. It dropped another 5 percent the next day.
What explains the despair? A look at Obama’s platform suggests that he plans four big changes that, if implemented, could have terrible economic consequences. Think of them as the Four Horsemen of Obamanomics.
The First Horseman is a bill, the “Fair Currency Act,” that Obama co-sponsored last May. If this bill becomes law, it could ignite a trade war similar to the Smoot-Hawley catastrophe that contributed to the Great Depression.
The bill allows the U.S. to impose duties on imported Chinese products to offset China’s purported currency manipulation. Michigan senator Debbie Stabenow has argued that the measure will “protect” Americans from China and other countries that artificially lower the cost of exports. Imposing new duties on these products, according to the bill’s supporters, would “level the playing field” and would restore the competitive position of American manufacturers in the global marketplace.
But such “protection” is never the end of the story. If we impose duties, others will respond in kind, and trade will suffer. During the campaign, Democratic economists apologized for Obama’s anti-trade rhetoric — they claimed he understood the benefits of free trade and was just scoring political points. We will soon find out whether such reassurances were justified.
The Second Horseman is “card check.” Card check allows union organizers to form a bargaining unit once they receive signed authorization forms, or “cards,” from a majority of employees. The National Labor Relations Act currently permits this, but also allows employers to challenge the results and require a secret-ballot election. The Employee Free Choice Act, which passed the House last year and was defeated only by Republican opposition in the Senate, would take away the right to challenge card-check petitions except when fraud or coercion is suspected. Arguments against card check often focus on fairness: By taking away the option of a secret-ballot election, card check would make it easier for union bosses to intimidate workers into acquiescence. But consider, also, the impact of further unionization on businesses: Costs would skyrocket, profits would tank, and bankruptcies and job destruction would follow.
The Third Horseman is tax policy. While much of the political debate centered on Obama’s plan to increase marginal tax rates on the “wealthy,” a little-known footnote to his plan was a call to end the deferral of tax on the profits of U.S. multinational corporations. This is the most alarming of his many proposals.
American firms currently compete in the world economy with an enormous disadvantage. The U.S.’s nominal corporate tax rate, 35 percent, is the second-highest among OECD nations. The gap between our rate and our trading partners’ has been growing sharply; the average corporate rate among non-U.S. OECD nations had fallen all the way to 25 percent by 2007.
A little-appreciated aspect of the tax code has proved the salvation of our multinationals during these high-tax times. If a company locates its profits in a subsidiary based in a low-tax country, it does not have to pay U.S. tax on those profits until the money is sent back to the United States. So a subsidiary operating in Ireland, where the 2007 corporate tax rate was 12.5 percent, can sell its product in France and let the profit pile up in an Irish bank account indefinitely. In this scenario, the disadvantage of the U.S. rate is reduced significantly. Democrats have raged against such deferral, arguing that it encourages firms to move their activity overseas. But deferral is necessary only because of the high tax, which is in and of itself a reason for businesses to go elsewhere.
If Obama successfully ends deferral, our multinationals will suddenly find that costs have dramatically shifted in their disfavor. They will lose business to competitors that operate in low-tax jurisdictions, and cut back employment both here and abroad.
The Fourth Horseman is regulation. As a candidate, Obama blamed deregulation for our economy’s woes, and promised to crack down with new regulations if elected. One can bet that Obama’s efforts will not focus solely on the financial sector, and that many new costs will be imposed on American businesses generally. This despite the fact that most deregulation has been achieved on a bipartisan basis, and widely hailed as successful. Trucking and air travel, for example, are two industries that deregulation has made more efficient.
Given this list of bad policies, it’s little wonder that investors have headed to the exits. The collapse of housing prices and the financial calamity that ensued certainly started the process, but it’s hard to imagine that the market would have plunged this far without the magnifying effect of Obama’s policies — and the most chilling thought is that the market probably has not fully factored the Four Horsemen into current stock prices. It is an open question whether Obama will pursue all of his campaign promises, but the threat that he might has markets predicting apocalypse.