I fondly remember “the good old days,” when government actually worked much of the time, when a conciliatory spirit was a badge of honor, and tough issues were resolved thoughtfully and with civility.  Howard Baker, Tennessee Senator from 1967 until 1985, exemplifies a leader who set the tone for those times. In his day he became known as “The Great Conciliator” for his ability to bring lawmakers from both political parties together, mend fences with his own party’s conservative bloc, and resolve pressing issues, like the contentious Panama Canal Treaty of 1977.  One must give Baker considerable credit for political courage in facing the wrath of the conservatives when he supported the Treaty, even when he was up for re-election.  Though small in stature, he stood tall in his ability to bring people together.

Our country needs a few Howard Bakers now.  This week we explore how dysfunctional government is affecting us economically, and how further dysfunction could threaten us.  This is all discussed within the backdrop of the choice of Janet Yellen as successor to Ben Bernanke at the Fed.  The Economist, the British publication, warns about the zeal of the right threatening serious harm. Even if cooler heads do prevail, blunt spending cuts are the more likely outcome in this environment rather than the long-term reforms actually needed.  Next, Ken Rogoff of Harvard warns of the negative consequences of default and its potential for undermining the international community’s faith in the dollar as the world’s reserve currency; he also emphasizes that, while concern for the debt is important, there are other issues that should be accorded similar priority.  Finally, Mohamed El-Erian of Pimco emphasizes that the Fed is limited in its policy-making effectiveness—more effective policymaking tools are available if legislative impasse is broken.

Good news at the Fed does little to offset the dreadful mess on Capitol Hill.  The President has chosen Janet Yellen to succeed Ben Bernanke as chairman of the Federal Reserve.  Her selection “implies continuity in monetary policy…her determination to keep monetary conditions loose should support growth.”  However, her ability to shepherd the Fed is “overshadowed by the brinksmanship on Capitol Hill…the consequences of this fiscal insanity are likely to be bigger than many now expect, for two reasons.  First, the fanaticism of some Republicans suggests that the stand-off may not end until it does serious harm…second, even if cooler heads prevail earlier, any budget compromise is likely to be followed by fiscal decisions that will hurt America’s growth…judging from the pattern of the past two years, any subsequent negotiations are likely to lead to blunt spending cuts that hit growth today rather than to the long-term reforms to tax policy and entitlements that America needs.  The antipathy between the two sides makes a sensible “Grand Bargain” budget deal hard to imagine… Far more likely is serial brinksmanship punctuated by short-term cuts-both of which bode ill for growth….against this backdrop it seems all too likely that America’s growth will, once again, fail to accelerate.  It also means that responsibility for supporting the recovery will remain, disproportionately, with the Fed…there are limits to what the Fed can do…they cannot protect an economy against destructive politicians.   If America’s recovery is to continue, let alone accelerate, congressional Republicans must come to their senses, and fast.”

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America’s Endless Budget Battle.  “If Congress continues to hijack US economic policy, it bodes ill for the economy’s otherwise bright long-term prospects…despite the federal government’s destructive impulses, the US economy is showing great resilience and looks set to become stronger…unfortunately, a US debt default, even a technical one, would have unforeseeable consequences that could threaten the recovery…the real risk is more profound than short-term dislocations…an unforced debt default now could dramatically accelerate the process

[where the dollar loses status as the global reserve currency] costing Americans hundreds of billions of dollars in higher interest payments on public and private debt over the coming decades…the US should worry about its soaring public debt…Americans should worry just as much [emphasis added] about the quality of education and infrastructure—not to mention the natural environment –that they are leaving to future generations But, above all, they need to leave a legacy of civil political decision-making [emphasis added].  That essential feature of effective government now is at risk.”

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The Fed’s Surprise and Yellen’s Challenge.  Janet Yellen confronts a difficult task when she begins her historic tenure, according to Mohamed El-Erian of Pimco.  Unfortunately, with the tools available to the Fed “none of this would significantly heighten the durable impact of Fed policy on economic growth and employment.  Other policymaking entities—particularly those with potentially more effective tools to help the economy reach escape velocity—need to act but are hampered by legislative impasse.  Meanwhile, continued and prolonged reliance on unconventional policies does involve unusual uncertainty and potential costs…no matter how hard it tries—and it is trying very hard—the Fed is still stuck with tools that are too blunt, and whose effects are too indirect, for the challenging tasks at hand.”

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And in case you missed itclick here to read last week’s blog post which focuses on  why markets have reacted mildly to the government shutdown.

We hope you enjoy reading these articles along with us and that you find them informative.  Please forward this to your friends and family.


J. Mark Nickell & Co.


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