Sunday, June 14, 2009

When politics and economics collide

I have posted before on how the political pendulum is swinging from Right to Left. Before anyone starts getting upset about the utter injustice of higher taxes, the government trampling on property rights, etc., we need to consider what happens when economics collide with politics.

The American Dream unravels?
In the United States, the social consensus of the American Dream, that anyone can succeed, has been the aspirations of millions and fueled many decades of economic growth.

What if American society experiences a severe enough dislocation that the mythic character of the American Dream is shaken? (See the discussion about the problem of low social mobility and high Gini coefficients in the US here and here.)

When the consensus moves too far to the Right and an economic shock occurs - the political pendulum swings Left. Edward Harrison of Credit Writedowns comments [emphasis mine]:

In 2008, the Democrats benefitted greatly from Barack Obama’s election as President, taking large majorities in both houses of Congress. Their mandate was to work with the President to fix America’s economic problem. So, Obama’s and Congressional Democrats’ first priority is to end the recession as quickly as possible. I guarantee you there would be hell to pay if this is not done well before November 2010 when the next general election is held.

From Obama’s perspective, it is crucial that he fix the banks and fix the auto industry as these were the two economic issues front and centre in the election which he said he could tackle. With the banking industry stabilised, the Obama legacy rides crucially on how the Auto Bailout proceeds. Under no circumstances is the Obama Administration going to allow General Motors to do to the economy in 2009 what Lehman Brothers did to it in 2008. They are going to fix GM no matter what it takes. And if this includes heavy-handed tactics, so be it.

So, be very clear that the GM and Chrysler issue is an existential question for this administration. Handle it well and you get the Roosevelt treatment and ensure a good outcome for your party in 2010. Screw things up and the depression bears down on America and you’re out of office in due course. The key policy decision is how to ensure a favourable outcome. And when I say favourable, I mean one that ensures as many jobs as possible while minimizing any wider economic fallout. Other issues like treating bondholders well, not committing taxpayer monies to the effort, or keeping government out of the auto industry are going to be much less important.

Harrison's comments extended beyond America’s borders:

[I]f Obama is concerned about his political fortunes because of an election next year, you can bet that Germany’s Chancellor Angela Merkel is concerned given her election is later this year. In Germany, cars have a mythical status…

Today there are hundreds of thousands of jobs in Germany tied to the auto sector, which has huge importance in the Rhineland, Germany’s industrial heartland and part of the most populous German state North Rhine-Westphalia, as well as in Lower Saxony, Bavaria, and Baden-Württemberg. In short, destroying auto jobs is a sure-fire way to lose an election. The ruling coalition is keenly aware of this and that is why they too will be very involved in the GM bankruptcy as it affects Germany through GM subsidiary Opel…

And I haven’t even mentioned the politics in Sweden, the U.K., Austria, Canada or Italy where this expected bankruptcy is equally important.

In other words, politicians have no choice. In times of crisis, rights get ignored (think Japanese internment camps) and trampled on.

Marxism realized?
As individuals, we can argue about whether a policy is right or wrong. As investors, we have to understand political realities and orient ourselves accordingly. Pat Martin, a Canadian legislator from a left-wing party, recently stated:

When I announce that I am a socialist, I guess it is no surprise because we are all socialists now. We just bought General Motors … The fact is that we now have Marxism realized. We own the means of production and we did not have to fire a single shot. It is really quite phenomenal what went on today.

Paul Krugman, in recent a New York Times op-ed article, blamed Ronald Reagan for our ills because of deregulation. While it is true that the pendulum started to swing right with the election of Ronald Reagan, deregulation didn’t cause all our ills. Excessive deregulation did.

The pendulum is now swinging Left, like it or not. At some point in the future, it will swing back. In the meantime, investors need to be aware of the social, political and economic backdrop of this investment environment and deploy their capital accordingly.

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