Priority Number One

As the global recession gathers steam, pundits are opining how the Obama administration will address priority number one, the economy. Clearly over the next sixty-plus days before the inauguration, President-elect Obama and his advisors will be busying themselves with analyzing the economic options that lie ahead for the nation.

Some of Obama’s team from President Clinton’s tenure may be noting something that I have considered: perhaps in retrospect, the US economy has been in a bear market for over ten years, starting with the 1997 Asian crisis and exacerbated by a deflationary spiral. Considering that bear markets often have strong bull spikes along the way, this would not be a crazy notion. If so, then the 2008 credit crunch and asset sell-off does not constitute the beginning of the process, but the final salvo that puts an end to global deflation and asset bubbles. Additionally, it would also argue for a continuation of the unprecedented global government intervention that is occurring under President Bush.

Regardless of where we have been, one thing is clear: the American people want action, but what form might that take? It looks like a centrist tone will prevail as the new administration faces the giant hurdles of a rapidly deteriorating economy and the overwhelming effect of the previous administration’s actions on the nation’s balance sheet. The effect of both of these factors should focus the President-elect’s attention on addressing economic concerns and could impede or postpone progress on addressing other long-term goals, like education and health care.

If the revival of the US growth engine is numero uno, then we should expect a significant stimulus plan immediately. Some are talking about $200 billion set aside to satisfy Mr. Obama’s desire to provide the middle class with tax cuts. For high wage earners, expect that the top tax bracket will increase to 39.6% and that capital gains and dividend rates will return to 20% from the current 15% level. The additional revenue raised from these increases is likely to help cover Alternative Minimum tax relief. On the good news side of the ledger for wealthier individuals, the plan would also extend the 2009 rates for estate taxation ($3.5 million indexed per spouse exemption and a 45% top rate). Many are also proposing infrastructure investment and direct grants to states for foreclosure mitigation.

What’s all of this going to cost? Estimates are for deficits to run from $1.5-$2 trillion next year, or at least 10% of the nation’s GDP. For deficit hawks, some of whom are among Mr. Obama’s closest advisors, this number is staggering. The rationalization for the massive spending is that government issuance of debt to help recapitalize the shaky financial foundation, is not spending, but should be seen as a necessary and massive re-fi. That does not mean that longer term interest rates will react as such—expect them to rise in reaction to these kinds of deficits. In the economic triage that is occurring, there is not much time to worry about those issues right now as we muddle through this unchartered territory. Bottom line: be prepared for the economy to be the number one issue for quite some time.