We know from Jeremy Grantham’s work on the “presidential cycle” that stock values rise on average 22% (based on the S&P 500) in the third year of a presidential terms relative to years one and two. This is not statistical noise. It’s evidence of the power presidents have to puff up stock markets through financial stimulus, political maneuvering and moral hazard.

Nobody who seeks political power is ever happy to give it up. So presidents try to give the economy a helping hand in time for elections. Bush, helped by a pliant Fed chief, did a better job at this than most. To say that the Fed’s monetary policy was loose in the run up to Bush’s reelection campaign is an understatement of epic proportions. George Junior had learned an important lesson from his father’s presidency: recessions don’t get you reelected.

Of course, the ensuing expansion of credit also helped by loose regulation of the shadow-banking sector and derivatives markets, couldn’t last forever. And the hero of the 2004 presidential elections left office during the biggest economic disaster since the 1929 crash.

President Obama knows his presidency will stand or fall on voters’ perceptions of his ability perform major triage on the wounded US economy. It does not, however, matter to Obama’s reelection bid if the economy assumes a sustainable pattern of growth; a good old-fashioned dose of ‘stimulus’ will do. Obama’s playbook is to borrow and spend America out of trouble. It is a short-term remedy at best. At worst, it will ruin the country.

The government will borrow 50 cents of each dollar it spends for the next year. To do this it will run the largest annual fiscal deficit since the US mobilized for World War II. There are only two ways to pay off the debt pile George W Bush and Barack Obama have run up. (President Clinton left office with a budget surplus.) The government will either raise taxes via the IRS or trigger inflation. It will likely resort to a combination of both.

This point is not lost on even Obama supporters. Warren Buffett had this to say recently about spiraling deficits:

A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, at some point, it’s going to inflate its way out of the burden of that debt.
Every country that has denominated its debt in its own currency and has found itself with uncomfortable amounts of debt relative to the rest of the world, in the end they inflate.
That becomes a tax on everybody that has fixed dollar investments.

Buffett thinks the ratio of debt to GDP in the US could reach 80% by 2011. Right now, the government has backstopped roughly 70% of the US economy with public funds. This is not a free market by any stretch of the imagination.
It is difficult to understand how the government will extract itself from this situation without triggering another collapse.

As we have said before here at Notes, traders and investors are now betting on Uncle Sam’s support of the market, not the market itself.

But if we’re going to make assumptions, we must also be willing to test them.

One common assumption we often see goes like this: if house prices fall, economic disaster will surely follow.

But a BBC survey suggests that things are not so clear-cut. Granted, this survey was part of the BBC’s attempt to plug one of its programmes. But nevertheless, its findings are interesting. While 22% of respondents said they want house prices to go up, 28% would actually prefer them to fall.

And these aren’t just prospective first-time-buyers hoping to get a foot in a door. Those already on the property ladder could benefit from lower prices too. Because while the value of their home will fall, so too will that of the bigger home they want to move to — and by a larger amount.

Also interesting is what the survey tells us about consumer confidence. When asked how they would respond to seeing house prices fall by more than a tenth, only 38% said they would cut back spending. Meanwhile, 60% said their spending would either be unchanged or would actually go up.

This makes intuitive sense. Many would-be home-buyers, be they first-time-buyers or those looking to climb the ladder, are obliged to save for long periods before they can afford to move. But if prices fall, the amount they need to save also comes down. Hence some people may feel inclined to spend a bit more.

It goes without saying that the BBC survey is very limited, commissioned as it was to promote a television show. But it provides food for thought. It reminds us that in matters economic, things are not always what they seem. The world is complex; causality can be messy and two-way.

It’s for these reasons that markets should be left to find their own level. House prices have risen in part due to a supply of cheap and easy credit. But this was unsustainable, and that supply has been curtailed.

Recommended

Fancy £4,064 this May? You’ve got till Wednesday 30th April to find out how…

This is the final invitation you’ll receive to rake in £19,500 – £48,000+ a year TAX FREE. Seriously, you’ll only need 20 minutes a day, an Internet connection… and the desire to dip your sticky fingers into a multi-billion pound honey pot. But you WILL have to act quickly!

On 30th April 2008 the doors will slam forever: this is your last chance to swipe sums between £95 and £3,880 in as little as 8 days!

The BBC’s survey shows us that some members of the public already seem to realise this. If nothing else, some of us are content to let the price mechanism do its job.

Those in charge of our economic policy would be well-advised to take heed.

Taxed!

Labour has traditionally been dogged by allegations of being a ‘tax and spend’ party. Tony Blair worked hard to dispel that image, moving the party to the right and adopting a more Middle England-friendly stance.

But a report by the Taxpayer’s Alliance (TPA) suggests that Labour in government is still more than happy to dip its hand in our pockets.

The TPA report states that the current tax burden — the amount of tax taken out of the economy — is £517 billion a year. When Labour came to power it was £294 billion a year. Adjusted for inflation, this means the tax burden has gone up 51% in real terms since 1997.

The culprits, according to the TPA, are not only higher rates of up front taxes (such as stamp duty, revenues from which have gone up more than 300%), but also stealth taxes and fiscal drag (which occurs when rising salaries move more of people’s incomes above the tax threshold).

Of course, these figures only tell half the story. As the economy grows, it’s only natural that the amount of tax, even in real terms, should rise.

“Tax as a percentage of GDP is around the same level as it was in 1997 and is well below the peak of the 1980s,” says the Treasury.

But I doubt many voters will listen. Today we have yet more bad news which demonstrates just how under the cosh Britons are. Factory-gate inflation is at a 22 year high. British Gas owner Centrica says it will be hiking prices again. Health secretary Alan Johnson reckons we’ll need to find another £6 billion in the next 20 years to provide adequate care to older people (i.e. many of today’s taxpayers).

Britain is getting poorer. All the stories mentioned above this paragraph are symptoms of that fact. And, rightly or wrongly, it’s the governing politicians who will take the blame.

Small wonder, then, that Labour über rebel Frank Field predicts Gordon Brown won’t be around by the time of the next election. I’ve lost count of how many “another nails” there’ve been for Brown’s political coffin. Brown’s stubborn, so expect him to cling on as long as possible.

Meanwhile, that coffin will just keep on collecting nails…

Marks tries to regain its spark

“Marks & Spencer’s is turning its back on an 85-year-old business model,” says our business researcher Theo Casey. “For the first time they could start stocking branded goods alongside their own.”

It’s quite a radical move for M&S. But is it the right one?

In today’s edition of Fleet Street Research, Theo explains that while there’s plenty to be excited about in the M&S story, you should also be aware of some flies in the ointment…