US: Midterms, Trade, and a “Fiscal Accelerator”

Published on September 10, 2018

With the US Labor Day weekend and summer holidays fading slowly into the rearview mirror, the traditional home stretch in the campaigning for US elections in November has begun in earnest, and the cascade of political reporting is pointing to the Democrats winning control of the House, with some pollsters even whispering about a possible (blue) wave-like 40 or more seat majority.

Whatever the margin, we have no reason to doubt the high odds being given to the Democrats in flipping the minimum 23 seats needed to take control of the House, perhaps even with a “flood” tide majority, or that the Republicans will as widely expected retain their narrow majority in the Senate. But contrary to a common assumption of consequences no more severe than a return to partisan gridlock, we think the outcome to the November elections could be hugely consequential.

*** An even more deeply polarized Congress, if that indeed is the result, may defy that conventional wisdom in two critically important ways. The first is on trade. As we have written (see SGH 7/12/18, “China: The Road to 500 Billion”) trade and specifically the fight with China trade policy is far more existentially tied-in to the Trump White House than a mere mid-term card to be played out in a few months. It is fundamental to the Trump presidency – and to his re-election prospects – and not only will the White House still hold the initiative next year, even with a Democratic House, but to our point, we suspect the president may find more support among Democrats than assumed even as they chomp at the bit to open impeachment proceedings against him. And Beijing may be miscalculating badly in expecting a weakened Trump, post midterms, to translate into a weakened US position on trade. ***

*** The second, and far less appreciated, consequence of a divided Congress next year is what we believe will be a high likelihood for another major round of fiscal stimulus. Freed by a near-neutering of fiscal hawks on Capitol Hill, pent-up spending demands among Democrats is very likely to meet little serious resistance among Republicans with their own wish list of higher military spending. For a president with remarkably attuned populist instincts, more spending will serve his own ambitions in 2020. Indeed, a revival of infrastructure ambitions will be at the top of both the House Democrat and White House fiscal agendas. It goes without saying, but such a “fiscal accelerator” effect would carry enormous implications for the economy and the markets in running so contrary to the Federal Reserve assumptions for a fading fiscal stimulus by the end of next year. ***

*** In line with what we think is a key “tell” to how fiscal and deficit caution will have little place in this new “growthier” GOP, House Ways and Means Chairman Kevin Brady this week will present the draft of a “Tax Plan 2.0” designed to make the individual tax cuts enacted last year permanent. It has zero chance of passage, but it is intended to serve as a voting record for GOP candidates to run on the invigorated “Trump economy” and his economically populist narrative. While vulnerable Republican incumbents in the purple or blue high SALT tax states will be even more exposed (see SGH 4/13/18, “US: Rescission, Midterms and 2020”), we think the White House-backed push for Tax Plan 2.0 is essentially Exhibit 1.0 that continuing fiscal stimulus will be the driving philosophy in Washington today, tomorrow, and into the election day of 2020. ***

We would be remiss at the outset not to acknowledge the relentless and expanding investigation into the Russian connection to the president and the Trump 2016 campaign by Department of Justice Special Counsel Robert Mueller.

But we think the “Mueller factor” is unlikely to have an explicit or direct impact on the November outcome, and that instead, with the investigation highly likely to go on deep into next year, and the president already granting a reprise to Attorney General Jeff Sessions until at least the midterms, its most noteworthy impact will be in spiking the partisan passions essential to the get-out-the-vote efforts by both parties.

Only One Name is on the Ballot: Donald J. Trump

It may be stating the obvious but while the president is not on the ballot, the elections are all about Donald J. Trump. Local or state specific issues will arise here and there, and some campaigns and voting will be driven by issues like the economy, the tax cuts, trade tariffs, immigration — insert your hot button issue here.

The single most important political factor going into these elections is that no US president in the post-war period has so dominated the news cycle every single day or managed through sheer weight of personality to make all politics about him.

Democrats are essentially betting the farm that the accumulative “Trump outrage” will be enough to override internal divisions within its wings and carry them to victory in the 2018 midterm elections. At minimum, the Trump factor should help pump up their get-out-the-vote efforts. Some 72 percent of Democrats, for instance, have indicated in multiple polls that they are “very motivated” to vote, and the Democratic turn-out has been high in the more than 30 states that have held congressional primaries so far this year.

The Trump passions, of course, are also working in the GOP’s favor in that the same polling shows some three-quarters of GOP voters highly motivated as well. Despite the rush of those headline shocks that would crush an ordinary politician, President Trump’s approval ratings among Republican voters remains rock solid and has in fact barely moved all summer.

What is good for Trump and political plays to his base may not necessarily be so good for vulnerable House Republicans in highly competitive congressional districts in blue or purple states.

Indeed, the balance of power in the House is unlikely to be determined by the voting in southern or rural districts or the white, blue-collar districts of the Midwest that tipped the scales in the 2016 presidential elections. Instead, the key 2018 races are almost all in the wealthy suburbs of northern Virginia, Pittsburgh, Miami, Denver, Atlanta, Detroit, and Kansas City where there is a high number of college-educated voters, independents, and women.

While the Trump support among his energized base may be holding, it is the independents, not each party’s base voters whose swing votes often determine the winner in closely contested races; the Trump GOP appeal to those independents look to be hitting new lows, with every indication so far that they are breaking to the Democrats.

The estimates of the remaining toss-up or competitive seats ranges from a low of perhaps 20 seats, just shy of a takeover, to as many as 75 seats, or a remarkable four times the number needed to clinch control of the House. And there is, for now, very little talk of any Democratic incumbents facing a serious GOP challenge.

In the closely followed RealClearPolitics average, Democrats are estimated to have a 7.8 point lead on the generic ballot question of which party does a voter prefer to run the U.S. House. One of the most respected pollsters, the Grinnell College-affiliated Ann Selzer reports a much lower 2-point Democratic lead among her survey of likely voters, a more cautious sampling technique to gauging outcomes. The outlier at the other end is the ABC News/Washington Post survey of registered voters with a 14-point lead for Democrats.

The post-war average “wave” outcome in midterms elections against the party holding the White House has been around 40 seats or so, and in 2010 the GOP picked up a remarkable net 63 seats. It is the ambition of Democrats to achieve similar results, which may be a hard hurdle to jump, but either way, Paul Ryan’s successor as House Speaker is very unlikely to be a Republican.

By contrast, the Senate is almost certain to stay in Republican hands. Just as the House favors Democrats in the wealthier suburbs, the odds overwhelmingly favor Republicans in the eleven most competitive Senate races that are in red, rural states where voters tend to be whiter, less urban, less college-educated, poorer and more pro-Trump. The GOP could even gain a seat or two against Democrats who are defending seven competitive seats.

Trump Trade Policies to Woo Democrats

By most accounts, an assumed outcome of a (large) Democratic majority control of the House and a (narow) Republican control of the Senate would normally mean a return to legislative gridlock and the familiar political dysfunction, perhaps previewed in the hearings for Supreme Court nominee Brett Kavanaugh last week.

But we do think next year will mark a departure from the norms of a divided Congress in the past on two fronts, even amid twitter firestorms and the subpoenas flying across town.

The first is on trade policy, where the initiative remains in the hands of the president. And while the merits of the trade tariff threats and negotiations over NAFTA, with the EU, and with China are all being hotly debated, trade is among the few policy issues strongly felt by the president.

What’s more, we suspect the declared aims of the Trump trade policies, to right the unfair slope of the prior trade deals and to bring “jobs back to America,” especially the higher paying manufacturing jobs, will in fact play pretty well among many factions inside the “Big Tent” of a newly emboldened Democratic Party.

After all, the blue-collar workers were historically the Democratic base, and there will be no small effort by the Democratic leadership to recognize the neglect of those voters in the Clinton 2016 campaign and to woo them back. So even as they object to every aspect of the Trump presidency, it may prove hard for Democrats to vote against policies pitched as helping the blue collar and the “hollowed out” middle America.

The Fiscal Accelerator

The second is what we think is very likely to be a second major round of fiscal stimulus under Democratic control of the House in the next Congress.

Ever since 2009, the Democrats have essentially been unable to pursue their domestic social agenda through most of the Obama years. That changed with the Bipartisan Budget Act of 2018 passed earlier this year, which added a mix of nearly $300 billion in Democratic-demanded non-defense discretionary spending nearly matching the Republican-driven increases in military spending. We think that success with the two-year budget deal will prove to be the template of what is to come.

There is certainly plenty of pent-up spending demand among the Democrats, especially among its newly energized progressive wing fired up with a winning rhetoric for a “stronger” Affordable Care Act, greater retirement security by “protecting” social security and an expanded Medicare, low cost or free college tuition support, and — in an echo of Trump’s initial “trillion-dollar” infrastructure plans that fell by the wayside this year in the drive for the tax cuts — the Democrats are highlighting a “robust” $1 trillion infrastructure spending program.

What will make such out-sized spending demands a reality are the changes to the political dynamics of the budget process. The most important is the demise of regular order in recent years, which has been replaced more or less by a scrum of competing spending wish-list demands pulled together in one massive Omnibus that makes it easier to slip in favored “pork” spending. More often than not, the massive Omnibus is passed only after a succession of stopgap Continuing Resolutions amid threats of government shutdowns, with openings for still more spending as the means to nailing down the necessary votes.

The other factor is that the budget is no longer driven out of the White House in a detailed budget plan with legislative language sent up to Congress after the State of the Union Address. Instead, crucially, all the initiative on budget priorities lies with the House, not the White House.

What’s more — and this perhaps is the critical political factor that will pave the way for a second round of fiscal stimulus next year — our sense is that political resistance to higher spending and ever larger deficits will be largely absent next year due to the political near neutering of the fiscal hawks in both parties.

For the Democrats, fiscal restraint in the both the Clinton and Obama administrations was followed in each case by Republican defense spending boosts and deficit-fueling tax cuts. For a solid majority of Democrats in the new Congress, that has translated into “fiscal integrity” becoming something of a toxic term.

The Democratic leadership is also likely to find itself using the promise of favored spending programs as their primary means of “controlling” its progressive wings and diverting their passions away from demands to change the party establishment: the more the progressive demands are met through higher federal spending on favored programs, the less likely there will be demands to change the system.

And an even more far reaching realignment is reshaping the power centers within the Republican Party. Like the remaining handful of Democratic centrists who might argue for budget restraint, the political leverage of the party’s traditional fiscal hawks will be even more diminished next year with their numbers so reduced in the aftermath of this November, that their voice will be inconsequential in the budget debate.

Likewise, the ability of the House Freedom Caucus to alter or restrain the spending trajectory — previously built around their blocking vote in the narrow GOP majorities under both Speaker Ryan or John Boehner — will be all gone in a Democratic “wave” majority or in reaching across the aisle to remaining GOP moderates for an additional cushion of votes if the majority control is a narrow one.

Trump’s Clinton-style “Triangulation”

And finally, with vastly weakened fiscal hawks within their ranks, and confronted with a big-ticket budget to follow on the two-year budget deal that will be ending a year from this October 1, Capitol Hill Republicans are likely to find themselves giving way to Democratic budget demands by President Trump.

The shift within the GOP away from its traditional free market, small government, restrained budget mainstream to Trump populism is already evident in the way the president has successfully brought the weakened GOP leadership in line despite what were initially significant personal and policy differences.

And if the president’s populist economic policy agenda is set next to the spending priorities being shaped by the Democratic Party, there is far more overlap between them than one would assume, with the remnants of the GOP mainstream being the outlier in the next Congressional session. It is more or less an echo of President Clinton’s famous “triangulation” to align a good part of his economic agenda to the GOP after their wave election victories in 1994 that left mainstream Democrats fuming at the time.

We think an embattled president is likely to offer only the mildest of resistance to the Democratic budget demands and in fact embrace much of it, especially the infrastructure programs as his own, in what will fit neatly with his own re-election ambitions in 2020.

We can’t be certain, of course, whether next year will indeed see a large-scale second round of fiscal stimulus, but we do think it more likely than not, and certainly far more likely than what the market is currently pricing.

That would especially be the case if the Federal Reserve is forced into a more hawkish response to a sizable fiscal boost, when its current base case assumption is for fading fiscal effects of this year’s twin fiscal stimulus by the end of next year, or exactly when this second spending boost may be taking shape.

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