A runaway deficit may soon test Obama’s luck

 

President Barack Obama reminds me of Felix the Cat. One of the best-loved cartoon characters of the 1920s, Felix was not only black. He was also very, very lucky. And that pretty much sums up the 44th president of the US as he takes a well-earned summer break after just over six months in the world’s biggest and toughest job.

His stimulus bill has clearly made a significant contribution to stabilising the US economy since its passage in February. His cap-and-trade bill to reduce carbon dioxide emissions passed the House of Representatives in June. He has set in motion significant overhauls of financial regulation and healthcare. Considering the magnitude of the economic crisis he inherited, his popularity is holding up well. His current 56 per cent approval rating is significantly better than Bill Clinton’s (44 per cent) at the same stage in his first term and about the same as George W. Bush’s.

Consider the evidence that the economy has passed the nadir of the “great recession”. Second-quarter gross domestic product declined by only 1 per cent, compared with a drop of 6.4 per cent in the first quarter. House prices have stopped falling and in some cities are rising; sales of new single-family homes jumped 11 per cent from May to June. Credit spreads have narrowed significantly and the big banks are recovering, some even making enough money to pay back Tarp bail-out funds. The S&P 500 index is up nearly 48 per cent from its low in early March. Best of all, the economy lost fewer jobs in July than most pundits were expecting. Non-farm payrolls declined by just 247,000, half the number that were disappearing each month in the spring. The unemployment rate has actually declined slightly to 9.4 per cent.

Credit where it’s due: although the gold medal for staving off depression goes to Ben Bernanke, the Federal Reserve chairman, and the silver medal to China’s leaders for their even more impressive stimulus, the president deserves at least bronze. According to Moody’s, the ratings agency, the stimulus package has saved more than 500,000 jobs. Without the jump in government spending, GDP would still be in a nosedive.

In foreign policy, as in economic policy, this is a president who makes his own luck. His Cairo speech in June was a big success and has even been credited by some for the recent setbacks for Hizbollah in Lebanon and for President Mahmoud Ahmadi-Nejad in Iran – though in truth the crisis in Tehran has been a serious blow to the administration’s strategy of negotiating with Iran. The press has put a very positive spin on former President Clinton’s mercy dash to North Korea to secure the release of two American journalists, despite the reality that this, in effect, rewarded the world’s craziest regime for its missile firings. If you still don’t believe this man is lucky, think of those Somali pirates shot dead back in April by Navy Seals rescuing Captain Richard Phillips. If Jimmy Carter had tried a stunt like that, the Seals would have hit Capt Phillips and missed the pirates.

Felix the Prez is lucky in domestic politics, too. After months of wrangling, Al Franken was finally confirmed as senator for Minnesota, giving the Democrats a potentially crucial margin of advantage in the upper house of Congress. To prove the point, the Senate last week voted by 68 to 31 to confirm the president’s pick, Sonia Sotomayor, as the next associate justice of the Supreme Court. In the House of Representatives, Mr Obama’s party has a majority of 256 to 178. Best of all, the Republican party has traded in Newt Gingrich’s 1994 Contract with America for a suicide pact with itself. Between Sarah Palin’s baffling decision to quit as governor of Alaska and Mark Sanford’s Argentine affair, the Republicans look not just leaderless but clueless.

Yet this might just be where the president’s luck runs out. For precisely the power of his own party in Congress could prove to be a source of weakness rather than strength. On my most recent visit to Washington, I could not help being struck by the shift that has occurred from the imperial presidency of the Bush era to something like parliamentary government under Mr Obama. This president proposes; Congress disposes. It was Congress that wrote the stimulus bill and made sure it was stuffed full of political pork. It is Congress that will ensure the healthcare bill falls well short of being self-financing. Mr Obama recently snapped at an unnamed “Blue Dog” (conservative-leaning) House Democrat: “You’re going to destroy my presidency.” He could be right.

According to the polls, voters disapprove of Congress by 61 per cent to 31 per cent. What’s more, the two parties would be neck and neck if the midterm elections were held today. The reason is clear. While the stimulus package had a sound macroeconomic rationale, the growing structural imbalance between federal revenue and spending scares the hell out of voters. A recent USA Today/Gallup poll showed that 59 per cent of Americans think government spending is excessive. Mr Obama receives his lowest approval ratings for his handling of the federal budget deficit.

. . .

Voters have good reason to disapprove. The deficit this year is likely to be $1,800bn (?1,270bn, o1,090bn). The gross federal debt is just about to bust the $12,100bn limit set by Congress. According to the Congressional Budget Office’s alternative fiscal scenario, public debt could rise from 44 per cent of GDP last year to 87 per cent by 2020. Spending on healthcare alone could rise from 16 to 22 per cent of GDP. The gap between spending and revenue in the latest House healthcare bill would be $65bn in just over a decade. The administration itself has no plan to balance the budget. Its own budget forecasts a trillion-dollar deficit as far ahead as 2019.

Mega-deficits as far as the eye can see are bad politics. They could be even worse economics. The nightmare scenario is that mounting fears over US creditworthiness push up long-term interest rates, thereby choking off the nascent recovery. After all, the great deleveraging still has a very long way to go. In relation to GDP, household net worth has slumped back to where it was 20 years ago. But household debt is still close to record highs at about 130 per cent of disposable income. Anyone expecting private consumption to bounce back is dreaming; real personal spending actually fell in June. Moreover, the property crisis is far from over. The number of prime borrowers behind on mortgage payments rose 13.8 per cent between March and June. The business default rate is already above 11 per cent and is heading towards 13 per cent. The contribution of the stimulus to growth (monthly spending as a proportion of GDP) has now passed its peak and by January 2010 will be zero. The public-private partnership to buy toxic bank assets has flopped. The official jobless rate conceals a surge in long-term unemployment to a postwar record.

Remember: this remains a global crisis. Any big external shock (for example, a European banking crisis) could abort economic stabilisation just as surely as the 1931 failure of Creditanstalt gave the world two more years of depression.

The president’s foreign policy could come unstuck, too. Iraq is likely to become more unstable as US troop levels are reduced. Mr Obama has committed himself to an escalating military effort in Afghanistan, the toughest country in the world to pacify. The administration seems to be overestimating the patience of the Chinese, who are deeply concerned about their vast dollar holdings.

Six months in, Mr Obama still has the look of a lucky, two-term president. But that could change if voters become even more disenchanted with the legislative branch and start blaming the president for the looming fiscal train-wreck. The scariest possibility for Mr Obama is that the runaway deficit could leave him with the worst of both worlds: exploding debt and flat-lining growth.

Even Felix the Cat’s luck ran out during the Depression. His creator Pat Sullivan drank himself to death in 1933, baffled that audiences now preferred mice like Mickey and Jerry. President Obama should take note.

 

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