The financial press has been right in saying the war is affecting the financial markets — which have been exhibiting a whipsaw pattern in the last two weeks. But if you look at the TV news, it is clear that the U.S. is dominating the war. Ultimately, the reporting and the markets will converge to the reality of the battlefield.
But my take on the effects of this war is a bit different than many analysts. The success and the speed of victory will affect the president’s popularity and that, in turn, will affect how much of his economic package will get adopted by Congress.
Just last week the Senate cut the Bush tax-cut package in half. Hopefully some of the cuts will be restored in conference. But how much will depend on the president’s popularity — and that will be tied to his success in Iraq.
Earlier this year the president’s economic program was dealt a blow by how it was scored by the CBO. Hopefully, as time goes on, the CBO will employ a better dynamic scoring system, one that includes the multiple substitution effects of tax cuts. But Bush cannot afford to wait two decades for this to happen.
Hence, he will have to sell his plan on the strength of his popularity. And the stakes are high: The more Congress reduces the president’s economic package, the slower the economic recovery and the weaker the market will be.
Certainly, there is already a clear connection between the president’s plan and investor behavior. Look at the recent surge in large-cap stocks. In part, investors jumped over to quality stocks because, with increased economic and global uncertainty, larger caps seem to be a safer alternative. But the move to large caps is also tied to Bush’s proposed tax-rate cuts. Whatever the shape of the package, the lower tax rates and lower regulations will benefit the larger-cap stocks.
So the question is whether we will get something near the original Bush package and/or whether Democrats will have their way and reduce the program in a significant manner. The recent Senate vote gave the Democrats a clear victory, and it suggests a slight change in the tax-and-regulation momentum.
But success in Iraq may recoup some of the Senate reductions. And with a more-intact Bush plan, and hopefully price stability in the U.S., we will be back in an environment that’s favorable to growth.