There are already more interpretations of Tuesdayís Republican sweep than you can shake a stick at, and a great many seem plausible. The most-often mentioned is that the GOP did not win as much as the Democrats lost, in the absence of winning issues. If anyone had suggested this political outcome in January 2001, when the Bush administration was launched with a GOP House and Senate, he would have had to assume the stock market would be a thousand points higher, not 2200 points lower. If he had also been told back then, when the Dow Jones Industrial Average was 10,800, that the Bush trillion-dollar tax cut had been enacted and the Fed had cut interest rates 11 times, he might have guessed the stock market would be roaring and the economy red hot.
In my mind, the voters could not blame Republicans or Democrats for the miserable economic performance because neither are to blame. The liberal Keynesian economists who advise the Democrats could never have imagined the budget would swing from a $175 billion surplus to a projected $175 billion deficit and aggregate demand would weaken! The conservative Keynesians in the White House who advised the President that putting $38 billion into peopleís pockets would turn things around could not have imagined the economy would worsen! If the monetarists had been told the Fed had opened the spigots and money supply had grown by leaps and bounds, they would have predicted another great inflation. Indeed, Milton Friedman is quoted in todayís Wall Street Journalís front-page piece on deflation (which is five years late) that inflation is the problem. In the same way, the voters could not be blamed for giving Democrats a victory in the 1934 off-year elections even though the economy was worse than it was in 1932. The Republicans were offering even worse prescriptions.
With the help of Saddam Hussein and Colin Powell, President Bush does deserve genuine credit for his handling of Iraq during the last month. Wall Street had been in a free fall in September as the likelihood of war increased. The market hit bottom when the President said, after a meeting with Powell, that he would use all means possible to disarm Iraq, including diplomacy! The market rallied sharply on that one word, and kept rising ever since as Saddam turned on the charm with a peace offensive that disarmed the Pentagon warriors. In the last weekend of the 2000 campaign for President, George Bush traveled with Paul Wolfowitz and topped every speech by promising the American people a national missile defense system. He lost three points in the tracking polls in three days and wound up counting chads for several weeks before the Supreme Court announced the winner. This last weekend, as the electorate was preparing to vote, the radio and television news announced the Presidentís barnstorming with a focus on jobs and the economy.
Just as importantly, there was Saddam Hussein announcing his willingness to accept a new UN resolution permitting the return of weapons inspectors. Iraq was really being taken off the table for most voters, as it appeared the President had resolved that problem with just the correct mixture of diplomacy and the threat of force. The iron fist of Vice President Cheney inside the velvet glove of Secretary of State Powell seemed to be getting the job done without war.
These first thoughts on the electionís outcome are sparse, as I usually must wait to see how the political class insists on reading the returns. I see Dick Morris, for example, announcing that the Bush victory gives him a free hand to go to war with Iraq and get it over and done with next year. I donít think that analysis will hold up, as the President has become too wedded to United Nations co-operation on ďdisarmingĒ Iraq, with or without a regime change. It is then up to Baghdad to make this work.
On the economy, the chatter on the cable financial stations is all about an end to the double taxing of dividends as being possible, with the GOP controlling Congress. But thatís only because Treasury Secretary Paul OíNeill brought it up the other day. There really canít be any blossoming of the economy, or of the stock market from here on, unless the deflation issue is addressed. Thatís why the WSJ piece this morning is important, even though the reporter, Greg Ip, does not understand the difference between deflation and contraction. There are people inside the Bush administration who do understand the issue, but need to be elevated in the shake-up widely expected before the new year begins. If Larry Lindsey really does leave his top post as chairman of the National Economic Council, it would be nice if the President dissolved the Council and looked to Glenn Hubbard who chairs the traditional Council of Economic Advisors. We note Hubbard has recently been discussing Fed policy, which previously had been off limits to him, as Lindsey co-opted that turf.
Treasuryís OíNeill might remain but he desperately needs fresh thinking at his elbow as his current team has flopped. We would recommend David Malpass, as we did 18 months ago. In his commentary today as chief economist at Bear Stearns, Malpass, who served on the Senate Budget Committee years ago, sees the possibility of an updating of the budgeting process, to dynamic scoring, as the current system is biased to higher spending and more taxes, because economic effects are not taken in to consideration. The added benefit to Malpass at Treasury would be that, like Glenn Hubbard, he really does understand the deflation process. He would actually make an excellent Treasury Secretary and would be my pick if I were President. Here is how he sees Republican Senate control on taxes:†
Bush's 2001 tax cuts will be phased in at least as fast as the current schedule and will probably be made permanent. It also increases the chances of a constructive fix to the Alternative Minimum Tax problem.† It might bring an investor-class tax cut or sweeping tax reform, though that depends to some extent on the outcome of the budget process issues. We expect even more interest in expanding tax incentives for savers given the popularity of IRAs, 401ks, Roth IRAs, 529 education savings plans, the government`s FERS plan allowing government employees to self-direct their pensions, etc.
As usual, the voters did the best they could. In New Jersey, I voted Republican for the Senate and Libertarian for the House and both candidates lost. I would have voted for Fritz Mondale if I lived in Minnesota. We were good friends back in the old days, when he was in the Senate and I was the political columnist for the National Observer.† But it is good the Presidentís party has all the primary levers of power, which in itself shakes things up and makes life more interesting.