Hamish McRae: We need to talk about the deficit

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While debate goes on in the US about economic recovery, a fiscal cliff looms.

The devastation wrought by Hurricane Sandy has distracted voters from the election. Photo / AP
The devastation wrought by Hurricane Sandy has distracted voters from the election. Photo / AP

It has been an extraordinary couple of days here on the eastern seaboard of the United States. It will take some time before the full cost can be gauged, but Hurricane Sandy looks like being a huge disaster in both economic and human terms. In Washington DC, we seem to have dodged the worst, but the rest of the east coast, home to around 60 million people generating the largest single clutch of economic activity on the planet, has not escaped so lightly.

The speculation is now about the impact on next week's election, but I believe the outcome will be determined one way or the other on economic issues.

Those are very simple. Has the economy under President Obama healed enough to justify his re-election? Or do people feel it might make faster progress under the more business-friendly Mitt Romney?

The background to all this is an economy that has turned the corner growing, according to last week's GDP figures, at an annual rate of 2 per cent.

That is not great, but there is a mass of evidence that economies recover very slowly from recessions associated with credit bubbles and banking crashes. The US had both, and on a massive scale. But it is officially past its previous peak, unlike Britain and the eurozone, and there are other signs of recovery. Car sales are 11 per cent up on last year and housing starts surged in September to their highest since the crash.

Some credit for this ought, in all fairness, to go to the Obama Administration. You could say that the rescue of General Motors and Chrysler worked. It also looks as though taxpayers have pretty much got their money back from supporting the banking system. On that last point, the US has done better than Britain has.

In one area, however, US policy has so far failed: jobs and unemployment. For a quirky reason, this may prove extremely important. US employment is well below its previous peak and job growth has been modest. But unemployment dipped suddenly last month, to 7.9 per cent. Until last weekend, I hadn't realised President Obama had made it a central aim to get unemployment below 8 per cent: perhaps unwisely, he asked to be judged on this.

It matters because this Friday sees the last bit of economic data published before voting next Tuesday: the employment and unemployment figures. As with most economic data, these initial estimates are based on partial data, sometimes just on surveys, and are frequently revised. So it is quite possible that the unemployment figure will jump above 8 per cent, even though the long-term trend is still slowly down. It is absurd that one number should be so important, but in an extraordinarily tight election, it could just tip it. So the answer to, "Has the President done enough?" is on a knife-edge. It ought not to be, because the past few months have seen real progress, but politics is capricious.

What about the case for the more business-friendly challenger? If it comes to money, the US investment community has a simple rule of thumb. Romney would be better for equities, whereas Obama would be better for bonds. The argument is that the former would bring in policies that, on balance, favoured companies - less regulation, tax cuts - whereas the latter would press on with the Federal Reserve policy of quantitative easing, which would hold down interest rates.

Actually how well America Inc does will surely be determined by the strength of the recovery not just in the US but worldwide, rather than by the next administration. As for bond prices, that is also really a global issue, too, for US bonds move pretty much with prime global ones - though US policy has an influence over those, too.

You might think that when people are worried about their jobs they would want a business-friendly administration but it does not necessarily work like that. Part of Main Street USA is deeply suspicious of big business, and particularly of big banks. Is Romney too much a spokesman for this chunk of America? Nothing obvious coming up in the next few days will tip this either way except perhaps some unpredictable chance remark.

There is something else. The great surprise for a visitor to Washington interested in economics and finance is that what, from the outside, seems the most important issue facing the US hardly features here. It is what on earth it will do about the fiscal deficit.

There is a debate about the so-called "fiscal cliff", the tax increases and spending cuts that come in automatically on January 1, if nothing is done to stop it. On paper the impact is huge, amounting to anything up to 5 per cent of GDP. People tell me something will be done and maybe that is so. But there may be a timing problem if there were a change of president or any major shift in Congress, because the old Congress and old President are still in office until January 21.

But if professional Americans here in DC seem strangely unconcerned about this, they are even less worried about the longer-term matter of balancing the budget. The deficit has narrowed a little, but is still 7 per cent of GDP. Much of that has to be borrowed from the rest of the world. At the moment, as a "safe haven", the US can do it and at interest rates below inflation. But reason says that this cannot last and we really have no clear idea what the next administration will do about this.

Looking out over a still-blustery Washington, I appreciate this is not an issue for most Americans. There is a lot to be fixed and the huge resources of the US will be swung into action to recover from the storm. But a year from now? Whoever wins, the economic recovery will, I think, no longer be such a concern. Independent

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