3rd October 2013
I was in New York last week and investor focus there was on politics, from the prospect of debt ceiling brinkmanship in the US creating widespread volatility to détente with Iran stripping oil of its geopolitical risk premium and early Italian elections unsettling the calm in Europe. I think developments in technology and particularly social media are playing an overlooked role in undermining the traditional party political model and will create growing volatility; Republican Congressmen and Senators with Presidential ambitions answer to the virulently anti-Obamacare ‘Tea Party Taliban’ in real time via Twitter, undermining the authority of party leadership. Obama himself used technology very effectively in his last campaign to get his core vote out among ethnic groups like Hispanics and the young. Perhaps most intriguingly, in Tehran, where internet access is censored and Revolutionary Guard spies eavesdrop on café conversations, the parks and squares are full of thousands of kids using Bluetooth on their phones to circumvent controls and support the reformists. Combined with record youth unemployment and a collapsing currency, the impetus for a breakthrough ‘grand bargain’ on nuclear and Syria looks promising but it would drive the Republican fringe even more apoplectic. As ever, the impact of technology cuts both ways…
In fact, several seasoned observers I met believe that the impact of tech savvy right wing activists means that the Republican party will split into at least two factions soon, perhaps in the aftermath of what amounts to outrageous debt ceiling extortion (strip funding from Obamacare or we let US default) which gives the extremists no way out. The current government shutdown in and of itself won’t have too much material impact. If it extends to the 21 days in 1995 and 1996, it could shave 1-1.25% off Q4 growth (although back pay to the 800,000 laid off Federal workers would then feed into Q1). Even if the debt ceiling is breached, there are mechanisms in place to avoid a default, although the US credit rating would likely be downgraded again. It will be a tense and volatile few weeks, but overall, the market reaction to the unedifying stunts in Washington is far calmer than in mid-2011 because the underlying economy has far better momentum, notably from autos and housing with small business hiring and corporate investment intentions looking positive into 2014 and state and local government payrolls growing again with tax revenues.
In fact, current growth would be well over 3% without the 1% or so fiscal drag from the sequester mandatory cuts earlier this year during the last political showdown in Washington, and the fiscal deficit looks set to fall sub 2% by FY 2015. Most bullish longer term for the USD (aside from the improving energy balance, and it is remarkable that taxis and police cars in NY are now largely hybrids) is the sharp decline in healthcare inflation having run well ahead of broader CPI for decades was just 1% y/y in July, a 50 year low, which if sustained slashes longer term entitlement budgets. This has little to do with Obamacare directly, but reflects a greater proportion of out of pocket expenses as well as the squeeze on real household incomes driving price sensitivity and hence cost controls. The risk that healthcare might absorb 20% plus of GDP or more than twice the level prevailing in other advanced economies by end decade is now receding, and this shift will also suppress US trend inflation.