The next four years: realistic version
While I’ve tried to be open to more optimistic possibilities, it’s far more likely that the second Bush Administration will be more of the same, and worse. The problem for the winners is that the consequences of the Administration’s policies, still debatable in 2004, will be grimly evident by 2008, and there will be no one but Republicans to take the blame. In purely partisan terms, as I argued several times before the election, this was a good one to lose.
It’s impossible to predict in detail how things will turn out in Iraq, or on foreign policy more generally. But Bush’s first term made one thing clear. If there’s a way to stuff things up, these guys will find it. I expect there will be some initial talk on both sides about rapprochement with Europe, but it won’t last long: if the assault on Fallujah turns out as bloody as appears likely, that could easily be enough to any such process to an end.
Things are much clearer on the economic front. As I mentioned in my previous post, Reagan’s first term saw the implementation of crackpot “supply-side” theories in which tax cuts would produce long-run budget surpluses, but when they produced huge deficits instead, the orthodox Republicans took control and raised taxes, among other measures to bring the deficit under control. In the Bush administration, by contrast, not only have the crackpots become the orthodoxy, but they don’t even bother (much) with Laffer-curve theories about an eventual return to surplus. The current view is that sustained deficits are entirely harmless. It’s virtually certain that the first-term tax cuts will be made permanent, and probable that there will be some additional cuts, as well as relief from the Alternative Minimum Tax. On the spending side, I expect there will be some severe cuts in non-defence discretionary spending, but there’s not a lot to cut, especially if you exclude areas like agriculture, that have strong Republican protection, and the policy initiatives of the last Congress, like the prescription drug policy.
An even bigger problem, not mentioned at all in the campaign as far as I know is the trade deficit. The deficit has grown steadily, exceeding 5 per cent of GDP in recent months. Although it’s a mistake to view the trade and budget deficits as twins, the combination of a budget deficit and minimal household savings implies the need for a balancing deficit on the current account, if any net investment is to be financed. Without a rapid reversal, sustained high trade deficits will translate into exploding current account deficits, as compound interest works its magic. This implies the need for a further large depreciation of the dollar, and an increase in interest rates or both. For the moment, interest rates have been held down by the willingness of Asian central banks to buy Treasury notes. But this can’t last.
In the absence of a serious attempt to bring the trade and budget deficits under control, a substantial increase in interest rates is inevitable, and that will almost certainly imply a slowdown or recession.
fn1. Except maybe in relation to outsourcing