Outcome of Political Squabbles
Will Have Significant Impact on
the Future Direction of the Economy
Oceanside, CA – In September, a heavyweight bout is being waged for the U.S. economy. In one corner, we have the Federal Reserve (Fed) led by Chairman Ben Bernanke deciding whether to begin tapering its Quantitative Easing (QE3) program. In the opposite corner, President Obama and Congress are going toe to toe again about raising the federal debt ceiling. The outcome of these two struggles will likely determine the direction of the economy into next year.
For the past month, solid economic data has been met with quiet alarm. “No one is disparaging the improving U.S. trade deficit and employment picture, or rising retail sales, housing starts and building permits,” said Frank Chow, chief economist for Trade Show Executive Media Group, “but no one seems enthusiastic about it either.” Why? News headlines are warning us that the good data increases the likelihood the Fed will begin to taper its QE3 program in September instead of waiting until its unemployment target of 6.5% is within reach, Chow said. This means the Fed will buy fewer bonds and continue the reductions over time until it ends. In response, the bond and equity markets in the U.S. and worldwide, from Europe to Indonesia, have backpedaled with a vengeance.
Divergent Views on Timing of Tapering
Many fear that tapering now may literally knock out the economy by raising long-term interest rates and thus inflation, Chow said. Not all members of the Federal Open Market Committee (FOMC) agree with tapering so soon; there is still much disagreement over whether the economy is strong enough to grow without QE3 support. Many economists and analysts have expressed skepticism on whether the economy can continue to grow without support from the Fed.
The FOMC will meet September 17-18 to decide when tapering should begin. Roughly 65% of economists surveyed by Bloomberg expect tapering to begin in September. Market reaction has been so fierce that Bernanke has had to publically diffuse the fears, saying that his tapering statements were misinterpreted, promising the tapering would not end until mid-2014 at the earliest, and that the Fed will keep short-term rates near zero until unemployment reaches 6.5%, which economists predict will not happen until 2015.
Regardless of when tapering begins, interest rates are already climbing worldwide, especially the 10-year Treasury bond to which many rates around the world are tied. At the start of QE3, the Fed stated the program would last until their inflation and unemployment targets were met. Based on this proclamation, investors anticipated the $85 billion a month bond buying would continue until 2015. “This spurred a huge carry trade where investors got cheap loans to buy currency and invest them in other countries’ assets with higher potential ROI. Now the policy reversal has prompted these positions to unwind, resulting in equities and currencies being hammered as funds flowed out of their markets,” Chow said.
Chow believes QE1 and QE2 were probably necessary. “The Fed needed to purge the banking system of all toxic securities and replenish bank reserves to stem the credit crisis and to keep mortgage rates low, giving the housing market a chance to stabilize,” he said. Chow believes Bernanke was successful in accomplishing these objectives. However, he pointed out that QE3 was meant to encourage more lending and boost employment. Instead, it has created more market distortion of prices and contributed little to economic growth. Because markets did not know the “real” price on investments and capital, companies became cautious and more uncertain about the economy. Chow said the low rates did produce more speculation in housing and equities, but hampered savings by individuals and firms, discouraged companies from investing capital in the real economy, and failed to generate a significant number of additional jobs.
Gradual Ending of QE3 Will
Incentivize Business Investment
“In my view, the gradual ending of the QE3 program is likely positive for the economy in the long term because of free-market implications,” Chow said. “For example, with rates and asset prices returning to market, corporations will experience a higher cost for the $2 trillion in cash they’ve held in their coffers for almost four years. Once the dust settles, this will incentivize more business investment, dividends, mergers and acquisitions, and ultimately hiring.” Trade Show Executive believes the ripple effect will reach trade shows in the form of increased exhibitor participation as companies look to promote new products/services, expand into new markets, or increase market share. Increased hiring often leads to increased attendance. And finally, M&A activity among independent organizers is expected to heat up.
However, Chow is wary of the timing. Bernanke will not return for a third term in January and Larry Summers appears to be the front runner to replace him. In addition, six or seven members of the Federal Open Market Committee (FOMC) are expected to leave. Chow’s two key questions are: Why not wait to taper especially since several members think more evidence of a strengthening economy is needed? Why saddle new members with the consequences of such a significant policy change they had no part in implementing? Chow feels the only logical reason is pressure from the White House. “Numerous times this past month, President Obama mentioned the dangers of creating another financial bubble. Larry Summers is the most amenable candidate to eliminate the bond buying quickly and is an advocate for more direct government spending,” Chow pointed out.
Hitting the Ceiling over Debt
Meanwhile, across town, the U.S. Treasury has been playing daily accounting games for several months to keep the government from exceeding the almost $17 trillion debt ceiling. The Treasury estimates the game playing will end sometime this month. Chow said this will set up another potential battle between the two political parties and could be a repeat of two years ago when Standard & Poor’s downgraded the U.S. credit rating for the first time in history, the dollar took a dive, and sequestration was spawned. The resulting agreement in 2011 added $2.1 trillion to the ceiling and the government exceeded that in February this year. Congress and the President have since suspended the debt limit until September.
Global markets, which broke into turmoil with the unresolved crisis in 2011, await a resolution. “Markets have been patient through the fiscal cliff and the ensuing sequestration,” Chow said, “and the continued postponement of serious negotiation has highlighted the political inability to address the long-range solvency issues. Further delay or obfuscation not only could invite a crisis of global confidence in the dollar, but may also further downgrade U.S. sovereign credit rating.”
This time an agreement may be more difficult to achieve due to Obamacare and sequestration. A substantial number of Republicans in Congress have said no deal on the debt ceiling and budget or continuing resolution unless Democrats and the White House agree to defund or repeal Obamacare. The Democrats want to end the across-the-board cuts in sequestration, but in exchange, Republicans demand significant cuts to discretionary spending programs along with changes in Medicare and Social Security. Democrats in the Senate and the White House have shown no inclination to agree and instead believe the public (and media) will blame Republicans if the government does shut down.
However, the Obama administration already has delayed three major requirements of the health care bill:
- Capping patients’ out-of-pocket costs.
- The employer mandate for companies with 50 or more employees to offer health insurance.
- Verification of consumer eligibility for tax credits/subsidy purposes.
There is another House-passed bill to delay the law’s individual mandate since the employers got a reprieve, Chow said. “The President had threatened to veto a similar bill two months ago and Senate Democrats voted it down, but now there is more pressure to add this to the delay list.” One potential compromise would be to delay the entire law for a year in order to avoid a government shutdown, Chow said, but the President seems intent on implementing the state exchanges. Health analysts warn it isn’t practical to defund because many of the contracts to private companies for implementation will go forward regardless. For now, it appears to be a game of chicken until one side blinks, Chow said.
Political Rivalry Aside, Decisions
Will Have Major Consequences
Whatever happens, the outcome of the two struggles will have enormous consequences. Unfortunately, the fundamental and structural changes necessary to modernize our economy, which we explained in previous columns, will be pushed further back into obscurity. Next month, Chow will discuss the hidden underlying trends in the U.S. economy and what should be the top priority for our leaders in Washington, DC. Hint: it’s not Obamacare. In the meantime, expect the markets to be volatile and the economy to remain mostly sluggish as it has been for the last four years. Trade Show Executive’s Economic Forecasting Board expects the trade show industry to slightly outperform the economy, with some sectors, such as construction, leading the pack.
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