Obama faces major economic challenges in second term

DOHA: The new term in office for President Barack Obama could be even trickier than the previous one from an economic perspective, according to QNB Group analysis. The previous term started in the midst of the global financial crisis, while this one is starting with a looming fiscal crisis. Unless Congress can reach agreement, $600 billion of automatic tax increases and spending cuts are due to come into effect at the beginning of 2013, creating what is known as the "fiscal cliff". The US Congressional Budget Office (CBO) estimates that these would cut GDP growth by 4 percent, pushing the economy back into recession.
Rising government debt means that some fiscal consolidation is needed. Federal debt reached $16.2 trillion at the end of October 2012, near the ceiling of $16.4 trillion, which was set in August 2011. The increasing federal debt, which is already over 100% of GDP, could lead to downgrades by ratings agencies Moody's and Fitch in 2013.
The economy was in a steep recession when Obama entered office in 2009 as the financial crisis undermined the wider economy. Government debt increased sharply as efforts to support the financial sector and create jobs to stimulate the economy were put in place. As a result debt increased to 103 percent of GDP in 2011 and is forecast by the IMF to reach 107 percent by the end of 2012.
During Obama's term, Congress has been unable to agree on a fiscal policy to lower the deficit and reign in public debt, which has led to the enactment of automatic spending cuts and tax increases from the beginning of 2013. The US elections have not changed the political dynamics that drive US fiscal policy, according to QNB Group. Obama remains president, the Democrats retain control of the Senate and the Republicans retain control of the House of Representatives.
This implies a likely continuation of the status quo with ongoing lack of agreement and likely delays in implementing fiscal consolidation. It is critical to the sustainability of the US economy that action is taken to limit increases in government debt. However, a lack of consensus between Republicans and Democrats, essentially around whether to cut spending or increase taxes, has led to delays in implementing fiscal consolidation. Therefore, it is probable that the tax breaks and automatic spending cuts that are due to come into effect at the beginning of 2013 will be partially extended or delayed. This will also lead to increases in government debt and require that the debt ceiling is raised further.
The uncertainty created by lack of political agreement and the risks associated with rising debt and no credible medium-term deficit reduction plan, make it more likely that the US will face a sovereign downgrade from at least one of the major rating agencies in 2013.
Since 2008, real GDP growth in the US has been 0.8 percent. Although slower than emerging economies, this is marginally stronger than other advanced economies (0.6 percent) and significantly stronger than growth in the European Union (-0.2 percent) over the same period. This is an indication that the US economy under Obama has performed relatively well compared with other advanced economies, according to QNB Group. This is impressive, especially when it is taken into account that the financial crisis, in large part, emanated from the US. Whether this is a consequence of Obama's economic policy, or structural factors relating to the dynamism of the US economy and the flexibility of its labor markets, is open to debate.
On the monetary side, the distinctive economic policy of Obama's tenure has been the continuation of "Quantitative Easing" (QE), or the expansion of central bank balance sheets through the purchase of financial assets with newly created money. Ben Bernanke, the chairman of the Federal Reserve, is a leading proponent of this policy. Obama re-nominated Ben Bernanke in 2010 and is now likely to re-nominate him again in 2014 or nominate a chairman that will continue the tendency towards loose monetary policy.
Therefore, Obama's re-election makes the extension of loose monetary policies, such as QE, more likely, according to QNB Group. QE may have had some positive impact. By purchasing US Treasury bonds, the Federal Reserves has kept interest rates low. This could have supported the housing market as the number of housing starts increased from an average of 554,000 in 2009 to 745,000 as at September 2012.
It has also been argued that QE helps the jobs market by keeping rates low and encouraging investment. Looking at the jobs data - the economy has only been able to recover about 4.5m of the 8.7 million jobs that were lost from December 2007 up until early 2010. It is estimated that an average of 176,000 jobs need to be created each month from now for the next two years, just to get back to the December 2007 level of employment, and at a much faster rate to take into account the new entrants into the labor force. Statistics available for October 2012 shows that only 171,000 jobs were added to the economy in October, although this was higher than in recent months.
By expanding the monetary base, QE also weakens the exchange rate, making US exports more competitive, according to QNB Group. This may have helped support US businesses through the recovery. The purchasing managers index (PMI), a benchmark indicator of corporate activity, rebounded from lows of 33.1 in December 2008 to 51.7 as at October 2012. However, it is only just above the 50-point mark, which is viewed as the dividing point between expansion and contraction.
The increased likelihood of QE was reflected by a sharp increase in the price of gold as Obama's victory looked increasingly certain. The gold price rose by about 1 percent to a high of $1,731 per ounce. Gold prices tend to benefit from lower interest rates and a weaker dollar. Gold is also regarded as a hedge against inflation, which is likely to be driven higher by expanding the money supply through QE. Stock markets have also tended to react positively to QE, as it is regarded as generally supportive to the economy.
In aggregate, improving jobs, housing and equities markets and a recovering economy and business environment appear to have had a positive impact on consumers during Obama's tenure. The conference board's consumer confidence index has increased from 38.6 at the end of 2008 to 72.2 as at October 2012, rebounding to levels not seen since February 2008, as consumers became more optimistic. According to QNB Group, this may have strengthened Obama's hand in the recent elections, but the longer-term inflationary impacts of QE and the risk that it is distorting financial markets, as well as the heightened risk from the fiscal cliff and debt ceiling crisis could create some major challenges for Obama's second term.