Markets did not extend a warm welcome to President Obama’s second term. The S&P 500 and the Dow Jones both lost 2.4 percent. Investors are looking to the president to tackle national debt and unemployment.
“Have no doubt: yes, an enormous sum of money was spent on the campaigns; and, yes, many promises were made as the candidates sought to differentiate themselves. Yet, after an initial flurry, it is essentially déjà vu for investors,” writes PIMCO’s Chief Executive Officer Mohamed El-Erian in a note to clients. He notes that the fiscal cliff, tensions in the Middle East, and the European debt crisis are still problems waiting to be resolved.
The president has relatively little influence over the European debt crisis. However, there are several key issues to resolve in his second term.
Fiscal Cliff Threatens Economic Recovery
In an effort to reduce the national debt, Congress enacted legislation that was dubbed “the fiscal cliff.” It means that beginning in 2013, there will be automatic cuts in spending and increases in taxes worth $667 billion, or 4.3 percent of GDP.
When the law was enacted in 2011, politicians had hoped that the economy would be humming by the time the automatic cuts and tax increases happened. At this moment, however, the economy is still fragile. A fiscal contraction of 4.3 percent of GDP would all but assure another recession.
“With the status quo maintained, a divided government goes back to work to solve the Mutually Assured Fiscal Destruction problem,” writes JP Morgan Asset Management chief of strategy Michael Cembalest.
He points out that a Congress divided between a Democratic Senate and a Republican House will not make it easy for the president to find a quick and lasting solution. There are ways and means to postpone or nullify some of the cuts. These would further increase the national debt, however, which now stands at 102 percent of GDP.
Key Personnel Decisions
Secretary of the Treasury Timothy Geithner already confirmed that he will not be available for a second term. The desire to bridge the gap between Republicans and Democrats in Congress will likely determine the candidate for this key position.
Erskine Bowles, the chief of staff for the Clinton White House, could be an option that matches this criterion. Commentators say that Bowles has the experience and the credibility to work together with Republicans. At least the former is true, as he chaired the commission to reduce deficits—which ultimately failed—together with Republican Alan Simpson.
Another option is Obama’s current chief of staff Jack Lew. One benefit is that he is already acquainted with Obama’s way of working, and he is said to have good contacts with congressmen, including several Republicans.
Another key post to be filled is the chairman of the Federal Reserve. Many market commentators think that Ben Bernanke’s lax monetary policy helped Obama win re-election. Bernanke juiced markets with so-called “quantitative easing” programs, often at crucial times when both stock markets and the economy were not doing well.
“Bond and equity investors could well experience a series of ‘Groundhog Days’—finding that a hyperactive Fed (still struggling to compensate for the paralysis of other policymaking entities) remains their best friend,” writes El-Erian, who expects the Fed to remain in accommodative mode.
Bernanke’s term ends at the beginning of 2014. Obama has already said he would offer him a third term, but speculation abounds that Bernanke will decline. The former Princeton professor is said to be weary of the difficult macroeconomic environment and the lack of cooperation from Congress.
Nonetheless, the candidate to replace Bernanke will likely continue the current Fed policy of easy money. Larry Summers, who used to be secretary of the treasury under President Clinton, is one of them. He was a major proponent of banking deregulation at the end of the 1990s and is unlikely to upset the industry by tightening monetary policy.
Another relatively easy choice would be Janet Yellen, currently vice chairwoman of the Fed. She could simply continue the current policies, without upsetting the inner workings of the Fed.
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