I'm not a believer in conspiracy theories, but I am a firm believer in Public Choice Theory.
Want to know the key to American politics? Assume all politicians are working for their own benefit, not that of the public.
Republicans and Democrats are battling over the debt ceiling extension, with neither side in firm control of the debate. The eventual result of this debate will have major effects on the economy.
But the Republicans are more interested in its potentially huge impact on the 2012 elections – there's just about time for actions taken now to work their way through the system and swing the economy in one direction or the other by next November.
Without believing in conspiracies, one can make a clear statement about what kind of economy each party would like to see 16 months from now, from their own selfish political point of view.
The Democrats would like to see rapid growth, with unemployment coming down sharply. They don't care so much about whether inflation moves up, or whether a huge budget deficit may cause trouble in the future.
If they get elected in November 2012, they'll sort out any problems then, especially if they can recapture the House along with the Presidency.
Conversely the Republicans would like growth to be sluggish, with unemployment stubbornly high. This could help them capture the Presidency and both Houses in 2012.
They want to make the painful decisions now that bring long-term growth later. The pain will be dumped on the current President's doorstep. While the Republicans will take credit for the growth when they take power.
This sounds cynical. But when you look at the history of politics in the U.S., you start to notice a pattern. And it's a pattern you could profit from. Investors who know how to maneuver around the election chaos have an opportunity to profit handsomely – no matter who's in office or what the economy is doing.
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Both the Republicans and the Democrats have strong beliefs about what policies work better, are better for the interest groups that support them and are best suited to their ideology. But at this stage of the election cycle, they care about winning, not about their ideals:
- The first years after an election are reserved for "pet" ideas – but only after they've won a big majority. This is why President Obama and the Democrat Congress spent much political capital on the "stimulus" spending and the healthcare bill in 2009-10. And it's why they tried to get a "cap and trade" carbon emissions program passed.
- Starting next January, in the run-up to the election, the main effort will go into rewarding powerful interest groups that provide money and votes. And focus will turn to popular gimmicks to get elected.
- After the election, there's a short period in which they do any "root canal" work – unpopular decisions that are considered necessary.
- But with the election still over a year away, the natural impulse in both parties is to ensure that the economic picture faced by the American public during the election is what they want it to be.
That's why President Nixon abandoned the Bretton Woods exchange-rate system in August 1971. It's why President Kennedy advocated his supply-side tax cut in 1963 (It was passed early the following year.). And it's why President George W. Bush pushed through capital gains and dividend tax cuts in 2003.
The Republicans have less power currently than the Democrats, but their objectives in the current negotiations are fairly clear.
They want a big spending cut – as big as possible – and to reduce the deficit as much as possible.
That's not just because they like spending cuts and deficit reduction. They also believe that spending cuts will result in public employee layoffs and may cause a short-term dive in the economy, even though they will improve long-term growth.
Short-term pain for long-term gain suits them fine, as any economic slowdown and increase in unemployment will happen before November 2012.
The Republicans don't want tax rates to increase. This would affect long-term growth prospects. And the electorate would blame them for it.
But they don't mind the elimination of tax subsidies, because the effects will be mostly short-term, or ending subsidized programs, even if it causes job losses.
They would like to cap the tax deduction for home mortgages and eliminate it for the wealthy, because it would probably cause another drop in the housing market.
The Republicans don't mind capping the tax deduction for the charity donations of high earners, either – Democrats support the vast majority of charities, except for the churches. And church donors are predominantly middle-income people who wouldn't be affected by a cap.
The Republicans also have a clear self-interest in monetary policy, though they are less able to affect that directly other than by harassing Ben Bernanke at Congressional hearings.
A "QE3" program of bond purchases would make the federal deficit easier to finance in the short term and boost the stock market. It would also increase inflation in the longer term. That would be bad news for Republicans and even worse news for old people living on savings – a Republican constituency. Conversely higher interest rates would help savers and slow the economy, and the Republicans would like both of those to happen going into an election cycle.
There are no conspiracies involved, just the natural self-interest of politicians for themselves and their parties – to the extent they're wise enough to figure out their true self-interest.
When scoring the debt ceiling debate and other economic policy moves this year, you can put a tick in the GOP column from all the policies on the above list.
Some of the wins will be accidental. Democrats will fail to figure out where their true interests lie in some areas – and GOP ineptitude may hand the Democrats a few freebies, too.
Keep your investments and your wealth out of harm's way in the next year. And don't let a political battle shred any profits you could make.
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