At the intersection of American politics and finance, located in the dreary departure lounges of the Washington-New York air shuttles, there is now a consensus about what will determine the outcome of the next Presidential election. From its left edges to the right, members of the parasitic class agree Barack Obama will be re-elected if the unemployment rate falls, and turned out if it does not.
A conservative National Review columnist chortles: “If unemployment really is 8 per cent or higher on Election Day 2012, then President Obama’s re-election chances are toast.” A left-wing blogger on the FireDogLake site avers: “If the general trend (in the unemployment rate) continues – and isn’t seriously slowed by the large cuts in local government spending or Obama’s idiotic willingness to embrace House Republicans’ anti-growth, immediate austerity measures – Obama will be in good shape for re-election.” Charles Cook, the centrist political technocrat, says unemployment is the first of “the primary roadblocks to Obama retaking the White House”.
Sorry, but they are wrong, or, at best, somewhat less than half-right, and so is much of Wall Street. All are grossly underestimating the political and market risks of a rise in the inflation rate.
Not only that, but when the political/financial world attempts to divine the future path of inflation, it is looking at the wrong indicators. The consensus is determined by the price of petrol, labour, and housing. But food and fibre prices are the more insidious challenge to price and political stability.
You can save some of the money you or your firms pay for political consultants by using the open-source model developed over the years by Ray Fair of Yale’s economics department. Starting in 1978, the appropriately named Mr Fair tweaked multiple regression analyses of presidential election outcomes from 1916 against various macroeconomic series. He initially found the most significant indicators were GDP growth and the inflation rate, which seem to be about equally powerful in determining the public’s willingness to re-elect the incumbent party.
He says: “If inflation goes up by a percentage point, the incumbent party can be expected to lose about two-thirds of a percentage point in vote share. Within any degree of significance, the GDP growth rate has the same effect [with the opposite sign].” Since presidential elections are usually decided by a percentage point or two, that is much of the story that can be read in advance. The unemployment rate, he has found, does not add any predictive value to the equation.
After the 1992 election, which over-predicted President George H.W. Bush’s vote share, Mr Fair added a “feel-good factor”, using the number of quarters during which the GDP growth rate is above 3.2 per cent. This made for a snug fit of the curve to the election outcomes, and the model hasn’t been changed since then.
While Mr Fair’s model’s equations are in the public domain, he publishes his own updated predictions every quarter. In January the model was giving Obama a 2012 vote share of 52.5 per cent, down from 55.9 per cent in November. However, that assumes three more quarters of high growth, and a GDP deflator in the first 15 quarters of the administration of just 1.77 per cent.
I have my doubts, in particular about the projected inflation rate. My sense is that we are going into one of those socioeconomic phase changes where models require not just a tweak, but a rethink. While Mr Fair considers inflation more than the Washington group-think does, he may be too optimistic about prices.
That is almost certainly true of the Fed and government projections, in which housing and wages weakness largely offset the rise in food and energy bills.
For example, the shelter component of the Consumer Price Index is about 32 per cent of the total, compared to 14 per cent for food, and 9 per cent for energy. If we spent all our time buying houses in depressed Henderson, Nevada, then we wouldn’t have an inflation problem. But no one is buying those houses now.
Susan Sterne, the consumer economist, notes that surveys show consumers believe inflation is around 4.5 per cent. “Most people equate that to energy, but the real issue is food. Consumers have learned to adapt to volatile energy prices, for example by driving less. They have less ability in the current setting to cut back on food.”
Another awakening problem is the increase in cotton prices. Ms Sterne says: “The rule of thumb is a 60 per cent increase in cotton leads to a 5 per cent increase in apparel. Now we are at a 160 per cent increase in cotton.”
And most of the bad price news has yet to hit consumer/voters. According to Ms Sterne, the consumer product makers and sellers in her client base are planning most of their price increases for the second half of this year.
Agricultural prices are a serious threat to political stability, even in rich America. Ask Bashar al-Assad how that worked in Syria.
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