American presidential elections are important events, although not all are equally critical. Some presidential elections occur during periods of relative tranquility, and presidential elections with an incumbent running tend to have less drama.
However, as we survey the political landscape for 2016, the next presidential election could be historic. In our opinion, the last three presidents have been unable to create a consistent foreign policy that reflects America’s role as the unipolar superpower. The next president will probably not have the luxury of this lack of policy focus.
History suggests that, geopolitically, unipolar worlds don’t last indefinitely. Eventually, the burdens of global leadership become too great, or other powers combine to contain the dominant nation.
The Great Financial Crisis (GFC) in 2008 severely weakened America’s ability to sustain one of the key responsibilities of the reserve currency nation, the ability to act as the global consumer of last resort. Global growth is difficult to sustain when the reserve currency nation is less able to buy the world’s exports and supply global liquidity.
The second role, the military role, is also coming into question. One of the jobs of the superpower is to act, at least in part, as a “global policeman.” That doesn’t necessarily mean that the U.S. must intervene militarily everywhere when bad things happen. But, it does mean the U.S. should protect the sea lanes and maintain general global order. Maintaining order requires the U.S. to have a credible military deterrent, which means America has the military prowess to intervene virtually anywhere and a leadership that knows how to prioritize where to act.
Syria’s use of chemical weapons against civilians violated a self-imposed “red line” by President Obama. He failed to act on that violation.
Understandably, Arab nations in the Middle East are now unsure about America’s position in the region. The Arab Kingdoms have tended to rely on the American military for protection against unstable neighbors; in return, the Arab states generally provided stable oil supplies. After Syria (and, to a lesser extent, Egypt) and with negotiations underway with Iran, the Arab states fear that this protection, provided since Roosevelt, may be ending.
Russia’s military takeover of the Crimea did not respect Ukraine’s borders despite the fact that the U.S. signed an agreement in 1994 with Ukraine to protect the country’s borders in return for Ukraine giving up Soviet-era nuclear weapons.
Not only has Russia annexed part of Ukraine, but it still has troops mobilized on the Ukrainian frontier and appears to be sponsoring unrest in the eastern portions of Ukraine, the home of many ethnic Russians. Russian President Putin’s government has suggested that the protection of ethnic Russian minorities in the Baltics, Moldova and Ukraine are paramount and discrimination against these Russians will not be tolerated. Whether this means Russia will respond militarily is unclear. However, it does appear that Putin is quite comfortable creating regional ambiguity on this issue which may extend further into the former Eastern Bloc.
Meanwhile, in the Far East, China is becoming a restive power, trying to project influence into the South and East China Seas. It regularly threatens the Senkaku Islands, which are claimed by China but have been under Japanese control since 1895. China has also been claiming islands under the control of Vietnam and the Philippines.
In this report, we will begin by examining the economic challenges the next president will face, with a broad analysis of the issues of inequality and economic growth. In future segments, we will detail our view on American politics and how these divisions affect the economy and the superpower role (Part 2). In the last segment, we will analyze how this presidential election season could bolster or end America’s superpower function depending upon how the politically powerful elites create coalitions to resolve the economic problem described in Part 1.
We believe these can be solved in such a way as to support the superpower role or end it. If our analysis is correct, it should offer insights as to how the candidates are positioning themselves in terms of maintaining or ending the superpower role.
As always, we will conclude with market ramifications.
The Economic Problem
Slow economic growth is plaguing the developed world.
This chart shows the five-year growth rate for inflation-adjusted GDP for the OECD nations as a group. This growth rate fell sharply during the GFC and has essentially not recovered.
Taking a longer term look, detrended U.S. GDP growth shows profound weakness.
This chart shows U.S. GDP, logtransformed, regressed with a time trend. The lower line on the chart shows the deviation from trend. Note that there are two periods when GDP fell well below trend, the Great Depression and the GFC. Following the Great Depression, after a catastrophic decline in economic activity, the economy rebounded. The reason the economy declined so rapidly was that policymakers allowed asset values to drop sharply.
Although this led to massive bank failures and asset liquidation, it did allow for new buyers to purchase these assets at deeply depressed prices. This supported the strong recovery. However, not all the recovery can be attributed to the “natural” process of letting asset values fall. The Roosevelt administration took aggressive steps to reflate the economy by devaluing the dollar against gold, and the increase in military spending before and during WWII clearly bolstered the recovery.
The current downturn has not been as deep as the Great Depression because policymakers took aggressive steps to prevent a wholesale decline in asset prices. Still, despite these efforts, the declines in both periods for housing were about equal.
The peak-to-trough home price decline from 1925 to 1933 was 30.5% compared to a similar decline from 2006 to 2011 of 31.8%. On the other hand, the peak-to-trough decline in the S&P 500 was 84.8% from September 1929 to June 1932; this compares with the 50.8% decline from October 2007 to March 2009. Monetary and fiscal policy prevented a repeat of the Great Depression’s stock market crash during the GFC.
What is disconcerting about the current situation is that there appears to be no end in sight to below-trend GDP. On the GDP trend chart, we use the consensus forecast for real GDP from the Philadelphia FRB Survey of Professional Forecasters for the years 2015-17. These forecasts show no signs that the economy is recovering toward trend.
The current slow growth has been dubbed “the New Normal.”2 Slow growth has caused significant distortions in the economy, especially in the labor markets. It has created a class of long-term unemployed that may prevent them from ever returning to meaningful work.
The chart below shows the percentage of workers who have been unemployed for more than 27 weeks. It currently represents 37.0% of all unemployed, peaking in April 2010 at 45.3%. As the chart indicates, as we approach the five-year anniversary of the end of the recession triggered by the GFC, long-term unemployment remains well above anything we have seen in the postwar economy.