About the Author: Desmond Lachman is a Senior Fellow at the American Enterprise Institute. He was Deputy Director of the Policy Development and Review Department at the International Monetary Fund and Chief Emerging Markets Economic Strategist at Salomon Smith Barney.
President Biden’s loss of his majority in the House of Representatives would bode ill for the US economy and its financial markets.
At a time when the country appears to be on the cusp of a significant economic recession, the last thing we need is a hobbled administration unable to respond to a swoon economy. Financial markets are already in retreat. The Treasury market appears illiquid. The tight-rope policy on the issue of raising the debt ceiling could drive up the US government’s borrowing costs even further.
In more normal economic times, one might welcome a locked-in Washington. Without a majority in Congress, any administration would lack the support needed for large increases in public spending or major tax cuts. This could help instill the fiscal discipline that has been sorely needed over the past decade. It could also help put the country’s public debt on a more sustainable path.
The truth is that we do not live in normal economic times. Last year’s reckless $1.9 trillion US bailout, along with the Federal Reserve’s ultra-loose monetary policy, contributed to economic overheating and soaring inflation to a multi-decade high. Meanwhile, the Fed’s zero interest rate policy, along with its excessive money printing, has led to an “everything” bubble in housing and credit markets in the United States and the rest of the world. world.
When the votes are finally counted and the new Congress convenes in January, it would seem more than likely that the United States has entered a significant economic recession as the Fed keeps interest rates high to regain control of the economy. ‘inflation. As on previous occasions, this coming recession will be led by a major burst of the housing bubble. It will also be caused by high interest rates which will limit consumer demand and by a very strong dollar which will reduce the competitiveness of American exports and reduce import costs.
Over the past year, US financial markets have swooned in response to the Fed’s new religion of monetary policy. Year-to-date, the US stock market is down 20%, the bond market is down 15%, and the cryptocurrency market is down about 60% in value.
At the same time, worrying cracks have appeared in the global credit system. Evergrande, along with 20 other Chinese property developers, defaulted on their debts. Meanwhile, the Bank of England had to bail out the UK pension system, and a number of emerging countries began to default.
A major problem with US and global financial markets is that they had grown accustomed to a world of zero interest rates and smooth economic navigation. If the US economy succumbs to recession and the Fed is forced to keep interest rates high to fight inflation, it is likely that we will experience turbulence in US and global financial markets before the new Congress didn’t have time to find his bearings. .
With financial markets already strained, the last thing we need is to be on the verge of raising the debt ceiling when the government hits its debt ceiling next year. Yet that is precisely what Kevin McCarthy, the likely new Speaker of the House, is threatening to do. Such a fight would risk a further downgrade in the country’s credit rating, as happened in 2011, which would increase the government’s borrowing costs.
In response to the deep economic recessions that followed the Lehman bankruptcy in 2008 and again after the 2020 economic lockdown, Congress introduced major fiscal stimulus packages to prevent a downward economic spiral. In today’s polarized political climate, President Biden’s loss of Congressional majority could lead to long delays in adequately addressing economic and financial market issues next year. If this indeed turns out to be the case, we should prepare for a deeper than normal economic recession and further turmoil in financial markets.
If ever there was a need for bipartisanship to address our difficult macroeconomic and financial challenges, it will likely be next year at a time of recession and financial market stress. However, I don’t recommend betting the farm that it will happen before things go from bad to worse.
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