About the author: Desmond Lachman is a senior fellow at the American Enterprise Institute. He is deputy director in the Department of Policy Development and Review of the International Monetary Fund and chairman of emerging market economic strategy at Salomon Smith Barney.
The loss of President Biden’s majority in the House of Representatives will bode poorly for the US economy and its financial markets.
At a time when the country seems to be on the cusp of a meaningful economic recession, the last thing we need is a hobbled administration unable to respond to a swooning economy. The financial market is on the backfoot. The Treasury market appears to be illiquid. Political brinkmanship over the issue of raising the debt ceiling could send US government borrowing costs higher.
In more normal economic times, we might welcome a Washington that is stagnant. Without a congressional majority, any administration would lack support for large increases in public spending or for large tax cuts. It could help with the budgetary discipline that has been lacking in the past decade. It can also help put the country’s public debt on a more sustainable path.
The truth of the matter is that we are not living in anything like normal economic times. The reckless $1.9 trillion American Rescue Plan last year, along with the Federal Reserve’s ultra-easy monetary policy, contributed to the economy overheating and inflation rising to multidecade highs. Meanwhile, the Fed’s zero interest rate policy, and excessive money printing, fueled the “everything” bubble in the US and global real estate, and credit markets.
When the votes are finally counted and the new Congress convenes in January, it seems likely that the US will enter a meaningful economic recession as the Fed keeps interest rates high to regain control of inflation. As in previous times, this coming recession will be led by a major burst of the housing market bubble. It will also be caused by high interest rates that will suppress consumer demand and by a very strong dollar that will reduce the competitiveness of US exports and reduce the cost of imports.
Over the past year, the US financial market has swooned in response to the Fed’s new monetary policy religion. Since the beginning of the year, the US equity market is down 20%, the bond market is down 15%, and the cryptocurrency market has lost around 60% of its value.
At the same time, ominous cracks have emerged in the global credit system. Evergrande, along with 20 other Chinese property developers, have defaulted on their debts. In the meantime the Bank of England has to liberalize the UK pension system, and a number of emerging market countries have started to default.
The main problem with the US and world financial markets is that they have become accustomed to a world of zero interest rates and smooth economic sailing. If the current US economy does not succumb to recession and the Fed is forced to keep interest rates high to fight inflation, it is likely that we will experience ructions in the US and the world’s financial markets before the new Congress has had time to find its feet. .
With the strain already being felt in the financial markets, the last thing we need is brinkmanship to raise the debt ceiling when the government reaches the debt ceiling next year. Yet that’s exactly what Kevin McCarthy, the likely new speaker of the House of Representatives, is threatening to do. Such a fight would risk a downgrade of the country’s credit rating as happened in 2011, which would raise the government’s borrowing costs.
In response to the deep economic recession after Lehman’s bankruptcy in 2008 and again after the 2020 economic lockout, Congress introduced a massive budget stimulus package to prevent the economy from spiraling downward. In today’s polarized political climate, the loss of President Biden’s congressional majority could lead to long delays in responding to economic and financial problems next year. If that is indeed the case, we should brace ourselves for a deeper-than-normal economic recession and for further financial market disruptions.
If ever there was a need for bipartisanship to address macroeconomic challenges and difficult financial markets, it will likely be next year in a time of recession and strained financial markets. However, I do not recommend the farm bet that this will happen before things go from bad to worse.
Guest comments like these are written by authors outside the Barron’s and MarketWatch newsrooms. It reflects the views and opinions of the authors. Send suggested comments and other feedback to [email protected]