"Elections and the economy: A Curious Case"

Posted On Friday, Aug 03, 2012

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Elections have recently been of utmost importance to financial markets then anytime in history. Elections and not fundamentals seem to be the prime driving force at the moment. Last month, people were glued to their television sets waiting for Greek election results and that too over a weekend. Elections in a small country like Greece had such an impact as an alternative outcome would have paved way for a Greek exit from Eurozone and thereby adding more uncertainty and risk to financial markets.


So why have elections become of such high prominence to financial markets? In the wake of the ongoing crisis, government intervention in financial markets has reached unprecedented levels. The health of the global economy is arguably as dependent on government as it has ever been. The era of bailouts, stimulus and interventionist policymakers that aim to resolve all economic issues by unlimited money creation have completely altered market dynamics. So when the governments are driving markets, you really care about who the government is and who is in power.


It impacts the real economy as well...


A major drawback of a government-steered economy is that high uncertainty prevails about what rules, regulations and policies will be enacted thereby making it more difficult for businesses and consumers to ascertain what the future might look like. The resulting lack of clarity, can indeed be disastrous.


In such an environment, businesses turn cautious and are less likely to hire new workers or invest in new factories. Similarly, cautious consumers are more likely to save money than to spend on optional items. With public debt reaching such high levels and governments showing signs of no return, people are increasingly worried on the promises in terms of benefits and entitlements that should be the right of the citizens. People are realizing the possibility of these promises be broken and are preparing for the worse. This type of policy uncertainty is on the rise and near historically high levels.


Who gets elected will have a big say in what happens. Part of what investors are dealing with is that they don`t know what policies will actually be put in place. Complicating matters is the fact that the weak economic situation, policymakers now face has never happened in their lifetime, which means there is no precedence to provide them with a course of action. We are in unchartered territory.


This time is different


Historically, elections have usually been bullish for financial markets as the party in power seeks to boost its chances of winning by pushing through policies that stimulate the economy ahead of the polls. It is indeed different this year. The debt crisis has highlighted the unsustainable course of running deficits and ballooned debt levels. This has taken off the ability from policy makers of creating money out of thin air and increase spending in order to garner votes.


It is indeed clear that the current path to spending beyond means cannot continue forever. At some point, elected officials will have to call it a day and follow the path to more rational order. It may also involve back out on the promises as it will be difficult for the government to fulfill all given the extent of their unfunded liabilities. Therefore, the personal finances are increasingly being influenced by politicians and policymakers around the globe.


But, Austerity is not an acceptable policy...


The stakes have never been higher. Election outcomes will shape economic outcomes. In many ways, the immediate fate of the eurozone was at stake when Greek voters went to the polls. Irate citizens unhappy with their economic plight have already toppled European leaders whose policies they disliked. In May, French President Nicolas Sarkozy, who viewed fiscal austerity as the best way to reduce rising debt loads, lost to socialist Francois Hollande, who favors pro-growth policies. Last year, Italy`s Prime Minister Silvio Berlusconi resigned amid questions about his economic stewardship. And what happens in Greece or Spain or China could affect what happens on world stock markets.


In the long term, the economy is still a major factor in determining financial security or what your investments would yield. But the outcome of key elections, such as the in Greece last month and upcoming votes in - America and other global houses of importance are likely to have a bigger impact on money-related issues. Policymakers are now the primary market movers. Investors are reacting more to perceived changes to policy as opposed to pure economics.


How critical can be US elections?


The US elections are increasingly been speculated upon and shaping market expectations. The presidential race between the "hope for change" elected current President Obama vs. Republican challenger Mitt Romney is, in many ways, a vote on whether Americans want more or less government involvement in their financial affairs.


First, let`s critically review how Obama has fared.


After three and a half years, Obama`s policies have led to 11 million less full-time workers and 8 million more part-time. The Obama stimulus plan was passed with everything he wanted. By October 2009, the unemployment rate was 10%. Obama`s stimulus package and economic policies have been so successful that he has been able to get the unemployment rate all the way down to 8.2% after three and one half years, even though he said his stimulus package would keep the unemployment rate under 8%. And all it took to get the unemployment rate down to 8.2% was for 8 million Americans to leave the labor force. Why 8 million Americans would leave the workforce when people desperately need income. If the labor participation rate had stayed constant, the current unemployment rate is 10.9%.


Low interest Federal government loans have skyrocketed from $100 billion when Obama took office to $450 billion today. Total student loan debt has surpassed $1 trillion, with the average student graduating with $25,000 of debt and many more burdened with $100,000 or more of debt. Default rates are already at a ten year high and are poised to skyrocket as more people graduate into a jobless job market.


His most successful program is clearly the SNAP food stamp program. When Obama assumed power in January 2009 there were 32 million Americans on food stamps and the annual cost of the program was $44 billion. Today there are 46 million Americans on food stamps and the annual cost is pacing at $75 billion.


We are left with a $5.3 trillion (50% increase) higher national debt and a $300 billion (2.3% increase) higher real GDP. The response you will get from his supporters is, "Imagine how bad it would have been if we didn`t spend the money".


This cynical assessment of Obama`s economic policies is by no means an endorsement of Mitt Romney or his economic plan, since we do not know if he does have an economic plan. While the Obama administration has a clear track record of running record deficits, don`t get your hopes up too high that the deficit trend will reverse should we get a Romney administration. The Presidential hopeful has already committed to continue subsidizing student loans and to keep up defense spending.


Obama believes government involvement in the economy is necessary to ensure that the middle class gets a fair share. He says the rich should pay more in taxes to reduce the deficit and keep the safety net for working Americans intact. Romney believes lower taxes, less government regulation and more business-friendly policies are the best ways to get the economy going again.


Almost everyone on Wall Street agrees that some form of fiscal economizing is needed to get the USA`s finances and economy back on track. Each year, the Congressional Budget Office (CBO) is warning in ever-clearer terms that the current path is unsustainable. In its 2012 long-term budget outlook, the CBO is warning of a 199% debt-to-GDP ratio by 2037 under its extended alternative fiscal scenario. There was only one presidential candidate whose proposals would have placed the USA back on a sustainable path. However, the Keynesian politico, their corporate cronies and their controlled mainstream media did their part in ensuring his way out.


The predictable...


If there is one good thing to be said about our policy makers, it is that they are rather predictable. And while we hope for change whenever we elect a new politician, odds are that business as usual continues. When politicians refer to "reducing the deficit", they typically mean reducing such deficit as a percentage of Gross Domestic Product (GDP), rather than in absolute terms. In practice, the cuts rarely ever take place. Deficits are nothing but future tax increases. Further aggravating the problem is rise of fringe parties that advocate extreme views in a bid to rise to power which are usually not the best way to solve economic issues and only add up having a more interventionist government. The free market principles and a natural cycle of correcting the malfunctioning and excesses in the economy have been severely hampered by the interventionist policymaking which is a cause for real concern. Government involvements have always acquired one of the many forms like Deficits, Debts, Quantitative easing aka printing money, more IOUs, currency debasement, etc. - all bad for the economy.


One of the main reasons that gold`s fundamentals are probably intact is because of erroneous policymaking theories which suggest that the economy can be made stronger via more monetary inflation, further credit expansion and more government spending. Make a strategic allocation to gold because it`s the counterweight to paper money which is continuing to lose credibility as a store of value.


Data Source: Bloomberg, World Gold Council



Disclaimer:
The views expressed in this article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments.

Statutory Details and Risk Factors:
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Risk Factors: All Mutual Funds and securities investments are subject to market risks and there can be no assurance that the scheme`s objective will be achieved and the NAV of the scheme(s) may go up or down depending upon the factors and forces affecting securities markets.
Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return. Investment in mutual fund units involves investment risks such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the Sponsor / AMC/ Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited (AMC). The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

Above article is authored by Quantum.

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