1. Stateside
The wolf is kept at bay – for now
The debt ceiling battle has not been resolved, just put off until 2014. Over coming months, the
issue will be swept under the rug and investors will focus again on earnings and the economy
The adults took charge
again. An entire
population and its
government was no
longer held hostage.
America expelled
a collective sigh of
relief in October as
soon as it transpired
Vanessa Drucker, that political leaders
Fund Strategy’s
had postponed their
American editor
wrangle over the
debt crisis and would
reinstate government
functions – for now. But was that outcome
ever actually in doubt?
In the American system, each branch of
government has the capacity to block the
others. Both chambers of Congress must pass
any law with identical bills, after which the
president can still veto. That requirement
essentially sets up a series of hurdles like an
obstacle course.
The country’s founders created a system
of checks and balances to accomplish dual
goals. First, they assumed that laws in
general restrict liberty, both by imposing
and prescribing activities. So they reasoned,
government should ideally be limited;
and the fewer rules, the better. Second,
when any federal law did pass, having come
through such an obstacle course, it would
reflect compromise and consensus.
The recent stand-off originated from
the extremist Tea Party faction within the
Republican party. With an ideology dedicated
to minimal government intervention, and
abhorrence of certain laws in particular, that
group of about 30 members rejected the
established tradition of compromise.
“It is one thing to use normal procedures
to extract consensus and make deals, but it
is a new level of danger to hold the whole
government hostage,” says Alain L Sanders, a
professor of American politics at Saint Peter’s
University.
“That is why Obama and the Democrats
refused to negotiate, believing that their
behaviour violated an understanding that had
existed through centuries.”
President Obama had demonstrated
on many occasions that he was willing to
compromise. Eventually, as the stakes were
ratcheted up, he realised the gravity of the
episode he was facing: a determined faction,
oblivious to the costs and the victims. In the
end, he recognised the tactic as an assault on
the entire system. “If he yielded, he would
6 Fund Strategy 30 October 2013
leave a weakened presidency to his successor,
whoever that might be,” Sanders notes. The
Democrats therefore decided that, if a crisis
must ensue, it should be resolved for once
and all.
Political theatre
But the debt ceiling battle has not been
resolved, merely put off until 2014, with
implications for investment managers.
Recent poll numbers suggest that
Republicans clearly lost this season’s skirmish
over a manufactured crisis, but that does not
mean the Tea Party itself will be chastened.
“After the Tea Party helped them gain a
majority in the House of Representatives,
Republicans had
looked the other way,
hoping the group
would calm down
and mature,” Sanders
points out, adding:
“The party leadership
recognises its strategic
error in letting a
monster grow, when
they allowed the
faction to mushroom.”
Perception remains
that Tea Party
representatives are
rogue members, as
well as extremists.
Yet these officials are simply voting as their
constituents want them to, and performing
what they were elected to do. Otherwise,
they would become vulnerable to primary
challenges in the next election. For instance,
although those in safe party districts would
not lose to Democrats, they might be
defeated by more conservative Republicans.
One significant difference between UK
and US systems is the lack of party discipline
in the US, where, once elected to Congress,
members can do as they please. Current
dysfunction results from a membership
overly responsive to constituents and a
system of negative checks. In other words,
without party discipline and no automatic
majority, it becomes harder than ever to
pass legislation.
“It is far easier to go home saying, ‘look at
my accomplishments in terms of the laws
I clocked’,” notes William Salka, a professor
of political science at Eastern Connecticut
State University. Legislative gamesmanship
and proactive blocking get keen attention in
their districts.
The party
leadership
recognises
its error
in letting
a monster
grow, when
they allowed
the faction to
mushroom
Meanwhile runs an undercurrent
discussion about automatically increasing the
debt ceiling, to preclude a repeat of this year’s
political theatre. That revision will never
happen, Salka insists, because such a move
would deny politicians a bargaining chip:
“Their goal is to get re-elected by showing
their voters that they are working for them,
and pushing their interests on the floor of
Congress through obstructions.”
Buy the dip
Over coming months, this issue will be
temporarily swept under the rug. The markets
did not sell off substantially, but struggled
modestly against the headwind. Now that the
urgency is no longer centre stage, investors
will focus again on earnings and the economy.
However, the drama has created either
an opportunity or a warning “that we will
go through this type of theatre any time we
have a point of leverage in the budget or debt
situation,” says David Twibell, president
of Custom Portfolio Group in Englewood,
Colorado. “Take that into consideration as we
approach those dates,” he suggests.
This time, investors never panicked
and the sell-off barely gained magnitude.
But Twibell likens the scenario to the boy
who cried wolf, as each crisis approaches
the brink before a deal is cut. He compares
the reactions in Europe, where markets
repeatedly plummeted over euro woes. By the
fourth round however, as a bailout for Cyprus
was structured in April 2013, the reaction was
short-lived.
The key for investors is to brace for the
next budget event and be prepared to buy
with conviction. Salka expects Congress to
revisit the matter in early 2014, but to push
out a solution to the following year, based
on the election calendar. Because House
members face re-election every two years,
strategies incorporate that schedule. “They
will use this winter’s showdown to get their
campaign speeches going, so they won’t be
bogged down at the end of the summer, when
they need to be home campaigning,” he
predicts.
Here is the crucial takeaway: members
will continue to play to home constituents,
but knowing all the while they will vote to
avert catastrophe.
Right up to the end they will posture
and filibuster, but again they will cave, and
markets will reward those who look beyond
the rhetoric. The wolf will remain at bay
a while longer.
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