James Srodes Repeating history

JAMESSRODES | Veteran commentator on Washington & Wall Street

Repeating history

Is Barack Obama following in the footsteps of Herbert Hoover?

Just as the American economy was showing flickering signs of recovery Mr Obama’s apparent failure of political will risks sending the prospects for growth plunging over a cliff that is entirely avoidable. Already a summer of discontent looms as business executives rein in plans for new hiring and expanded production lines in the face of uncertainty that Washington is about to slam the brakes on growth simply because of political gridlock.

And so it was 80 years ago with Herbert Hoover. Like Mr Obama, Hoover started out as the beau ideal of American Progressives. He had become internationally loved for his efficient programmes that brought food and medicine to Europe as it crawled out of the wreckage of World War I. Then he had been the very model of a modern cabinet officer for two successive presidents, instituting far-reaching policies that sparked the development of air and ground transportation, radio communications and standardisation of business products.

By 1928, the campaign slogan, ‘Who but Hoover?’ reflected the general acclaim of his rise to the presidency. Quite unfairly, Hoover was blamed for the stock market panic of 1929 and the Great Depression that followed. He was no more responsible for that global financial meltdown than Mr Obama was for the Great Recession that came on the heels of his inauguration three years ago. Indeed, Hoover began plans for a number of financial reforms – including reconstruction finance for infrastructure, the outlines of what became the Social Security pension system, and new rules to curb speculating on Wall Street— ideas later claimed as part of Franklin Roosevelt’s New Deal.

But like Mr Obama now, Hoover suffered a failure of will. He shrank from spending his political capital to get a recalcitrant Congress to enact his reforms. Worse, he gave his assent (despite his disapproval) when Congressional protectionists enacted the notorious Smoot-Hawley tariff increases that brought world trade to an almost complete halt. His faltering not only cost him a second four years in office but prolonged the Depression needlessly.

Tax-mageddon

In Mr Obama’s case the catastrophe he faces is both obvious and avoidable. The crisis is being called ‘taxmageddon’ and there are signs that business and investment planners are already trying to scale back expansion plans for next year in the face of the coming fiscal train wreck.

Unless Mr Obama can find a working majority in the Congress between now and the end of the year, roughly half a trillion dollars in tax increases will hit the recovery hard. This disaster is the result of multiple policy changes all set to hit at the same time.

Big tax-cuts enacted during the George W. Bush era are scheduled to expire in December, along with a temporary payroll tax holiday passed by Mr Obama to jump-start the economy two years ago. To further complicate matters, the failure of both Congress and the White House to reach an agreement on the level of federal government indebtedness led Congress to pair a debt limit increase with $1.2 trillion in across-the-board government spending cuts over the coming decade which would go into effect as of January 1.

In all, more than 100 targeted tax cuts will expire while a dozen new taxes to pay for the Obama health insurance mandate will go into effect unless some compromise is reached. Tax rates on estates, on capital gains, and on a minimum income tax levy on middle-income earners will all rise sharply. The new taxes target the cost of medicines and health insurance and may cost employees of small businesses their existing health insurance coverage paid by their employers.

Worse, there is every sign that the root cause of Washington’s drag on the economy – the federal deb – will exceed the legal limit of $1.6 trillion (more than US gross domestic product) soon after ‘tax-mageddon’ occurs.

No sector of the US economy will be spared: part of the mandatory spending cuts set into motion are sharply reduced payments to hospitals that care for the elderly, universities with science research projects and major defense industry firms. In just the area of government spending on defense technology, industry estimates are that more than one million jobs will have to be culled by the shrinking budgets.

In such a reversal can the United States escape a second down-grading in its international credit rating such as the one touched off by Standard & Poor’s and Moody’s a year ago?

Clearly, American CEOs are bracing for just such a downturn. If nothing is done, as appears more than likely, between now and December, the impact of the higher tax levies is estimated by most business economists to cost between 2 to 4 per cent of GDP growth. Since that growth rate has recently between reduced to a 2.2 per cent annual rate in the first quarter of this year (from an anaemic 3 per cent) there are signs that a further downturn is already in the works.

The Federal Reserve Bank of Philadelphia, which tracks manufacturing activity on the American Atlantic coast, reported the first contraction in eight months in general business activity during May.

The net result could be to topple the economy back into its second recession in five years. For the moment, Mr Obama appears to be gambling that not only will the voters return him for a second term in the November elections but will also overturn the Republican majority in the House of Representatives and give the president a Democrat-controlled Congress for 2013.

Mr Hoover tried the same thing. n