Why Clinton’s Policies Will End Up Like Bush’s

Now that the Presidential election is well past, stock and bond investors are wondering just how different a Clinton Administration will be from a second Bush Administration. In my opinion, the Clinton Administration won’t be vastly different from a second Bush Administration, at least for the first year or so.

Clinton will be hamstrung in large part by the enormous federal deficit, making it unlikely that he will embark on a big program of fiscal stimulus right away. Statements to that effect by Clinton advisers, aimed at calming bond investors, indicate that they do worry about Wall Street’s reaction to deficit-increasing actions. Why risk spooking the securities markets with a big fiscal stimulus package when the economy might revive by itself in 1993 or 1994?

I suspect that the initial emphasis of President-elect Clinton will be on the issues with which he has long been identified--education and training, and rebuilding the infrastructure. Bills in these areas may be proposed to Congress early in the new year. Clinton would also probably push his campaign promise to tax the rich and redistribute those funds to his middle- and lower-income supporters. Even this effort might not get too far, however.

The criticisms of both Bush and Perot, that Clinton’s tax on the rich won’t raise much revenue, is correct. There aren’t that many people with incomes over $200,000. In the third presidential debate, Perot observed that Forbes’ 400 richest Americans don’t have enough assets to cover one year’s federal deficit. Consequently, Clinton would have to hike taxes on much lower income groups, including his supporters, to raise the amount of money he plans to redistribute, or, for that matter, any amount large enough to seriously affect the economy.

In the first year or two, President Clinton would also spend considerable time and effort getting to know Congress and learning to work with that body.

Many fear that with Democrats at both ends of Pennsylvania Avenue, liberal spending programs will go wild. They forget, however, that Congress loves cheap thrills. By that I mean the ability to vote for a bill favored by constituents that Congress doesn’t really want but knows it can pass with the firm assurance that a Republican President would veto it.

Congressmen and senators love to tell their backers that they voted for their pet bills, regardless of how loony they are and even though the denizens of Capitol Hill would be aghast if they ever became law.

Now, with Clinton in the White House and Democrats still in control of Congress, the era of cheap thrills will be over. Instead, the average Democrat in Congress will have to think, “My God, if we pass this bill, Clinton as a fellow Democrat will have to sign it and the damned thing will become law.”

I’m not suggesting that a Democratic Congress would become arch conservative under Clinton, but rather, much more responsible and less liberal than many fear. Fiscal policy, then, may not be significantly different in the opening years of the Clinton Administration than in a second Bush Administration.

How about monetary policy? The Federal Reserve, of course, has already significantly reduced short-term interest rates with little effect upon the economy. As we have discussed many times in the past, in an era in which the huge debts built up in the 1970s and 1980s throughout the economy are being unwound, often in painful fashion, few lenders want to lend and few borrowers want to borrow. But that doesn’t mean that the Fed will stop trying.

After the current euphoria over the incoming Administration subsides, the economy will probably continue to grow slowly at best, and further reductions in Fed-controlled short-term interest rates are likely. Although the Fed is at least nominally independent of White House pressure, Clinton will undoubtedly applaud further credit easing in a sloppy recovery.

Big economic policy surprises, then, are unlikely for the next several years. But as the 1996 election looms and debt workout continues to retard the economy, Clinton may fear that he could follow Bush down the tubes as a one-term President, sunk by a lousy economy. Then, he might well embark on a massive fiscal stimulus program in an attempt to revive the business before the election.

The reaction to this on Wall Street would be ghastly. Many bond investors still vividly remember the high inflation of the mid- and late-1970s, the first major inflation in peacetime which caught them totally off guard. That 1970s inflation so exceeded bond yields that inflation-adjusted (real) rates fell to negative territory twice. To add insult to injury and double the bond holders’ plight, bond prices were declining at that same time as interest rates rose but still lagged inflation.

After two trips through the meat grinder in the 1970s, bondholders decided not to volunteer for a third, and demanded and got very high real return in the early 1980s, returns of 9% which vastly exceeded the earlier postwar norm of 2% to 3%. It took a decade for them to lose their fears and for real rates to decline toward the norm, but recent concerns over economic recovery and a revival of inflation which predated the Clinton scare, once again pushed up real rates. This shows clearly that memories of the 1970s live on.

In this context, the mere announcement of a big Clinton fiscal stimulus program several years hence would probably send real bond yields into double digits and virtually destroy the bond market. Stockholders’ hopes for corporate earnings gains spawned by fiscal stimulus might well be swamped by the negative effects on share prices of skyrocketing interest rates. The Federal Reserve might continue to hold down short rates but would be powerless to arrest the surge in long-term rates.

With security markets in disarray, corporate America would be very cautious in hiring people, in inventory building and in capital spending. Consumers might step up their saving rate to prepare for layoffs and rainy days in general in the face of extreme uncertainty. The dollar would collapse as Americans and foreigners rushed for safer havens abroad. In short, the stimulative effects of a Clinton fiscal policy might well be wiped out by the negative implications of the leap in interest rates, and in the end, the economy would remain stalled. Ironically, fears of inflation due to substantial fiscal stimulus would be rampant, but actual inflation would remain low due to continued economic malaise. Needless to say, Clinton would be a one-term President, the reverse of what he hoped fiscal stimulus would achieve.

I rather suspect that fears of an early big stimulus package will ease as Clinton announces appointments and plans, and that inflation fears will fade and the global recession again dominate investor thinking. The implication for bonds would be positive but not necessarily for stocks, since earnings disappointments would again be an issue. Investors would need to be on their guard, however, and watch the Clinton Administration’s fiscal policy carefully several years hence if the economy remains weak.