US Mid-term elections take on extra importance

10 min
Dan North
Dan North Senior Economist for North America

A rebalancing of power could occur after US mid-term elections with a significant economic impact

President Trump has led an extraordinarily stormy first year and a half which has created unprecedented political vitriol. He has failed to fulfill some campaign promises such as repealing and replacing Obamacare (although he has weakened it) and thus far has not built “the wall”. Yet he has also had significant political victories as well, including passing the tax package, deregulation, increased military spending, bringing North Korea to the negotiating table, appointing a conservative Supreme Court justice, and nominating another, the collapse of ISIS, and most importantly, a strong economy.  He doesn’t talk about the almost doubling of the US budget deficit over the last three years, but you can’t blame him, as Republicans - who used to be budget hawks - have become largely indifferent to it now that President Obama has left office. Someday, but not now, this might change.

However, the mid-term elections are approaching in November, giving the Democrats an opening to counter or even reverse some of Trump’s policies. Indeed Trump is loved by about 40 percent of the electorate but intensely reviled by another 40 percent. Up for grabs in this election are the twenty percent of the voters who may not have made up their minds, or whose views are more nuanced. A good economy and the feeling that the majority of people in the country believe it is moving in the right direction gives the Republicans comfort. On the other hand, the President’s popularity is only in the mid 40’s and this is a particularly bad omen when the country is almost at full employment. Public opinion polls give the Democrats a 7 percent edge against the Republicans on a national basis. Should this remain or increase, it likely that the Democrats would take control of the House of Representatives, and stand a 50/50 chance of reclaiming the Senate. Because of how the Congressional Districts are composed Republicans can still maintain control of the House of Representatives if they lose the national aggregated vote by less than 4 percent. Anything in between makes it anybody’s guess.

The outcome of these elections could have more importance than any mid-term elections in recent memory as with a new Democratic Majority, the Congress can not only stop the Trump legislative agenda at its roots, but could use the next two years to engage in all sorts of investigations designed to make the White House and the Government agencies a miserable place to work for Trump political appointees and probably the President as well.

Historically, the President’s party has lost ground in the mid-terms elections. On average, over the past 21 midterm elections, the President’s party has lost 30 seats in the House and 4 seats in the Senate. If that were to happen this time, it would give the Democrats a slim majority of between three and five votes in the House. In the Senate, Democrats (including independents) would hold a 53-47 vote margin over the Republicans.

Republicans are blessed by an excellent Senate map in which there are 33 seats up for a vote, with 23 being held by the Democrats. Five of them (North Dakota, Missouri, Indiana, Montana and West Virginia) are held by Democrats, but were carried by President Trump by more than 20 percent in 2016, making them promising targets for the Republicans. Still, these five Democratic Senators have won before and with deep local ties, and fully warned, each of them has a fairly decent fighting chance to hang on and win again.

There are therefore three possible scenarios:

  1. Democrats take the House but not the Senate. This is the most likely case with a probability estimated of around 60%
  2. Democrats take both the House and the Senate, with a probability of 25%
  3. Republicans maintain the majority in both the House and the Senate, with a probability of only 15%

 

 

In the third case, Donald Trump .

could be energized by a popular validation of his policy and complete his own personal domination of the Republican Party, which until he came along, was a strong supporter of NATO and Free Trade and an ardent foe of deficits. Much of this has already changed as the President has put his own unique brand on the party. A lot of Republicans are unhappy about this and have hesitantly fought back. Should the Republicans maintain complete control of Congress, expect President Trump to reign supreme.

A Republican win could lead to a reinforcement of recent policies. An extension of tariffs on larger amounts of imports (our trade feud scenario) and further de-regulation in the financial market is conceivable.

In either the first or second cases with the Democrats winning at least one House of Congress, the Democrats will have the ability, if they stick to party lines, to stop the Trump agenda in its tracks, or even roll back some of its achievements. To get some idea of what to expect, you could just look at the Obama administration which was unable, after its first two years in office, to secure any major legislation when the Republicans took control of the House of Representatives.  President Trump was legislatively blocked in had to resort to using his regulatory authority to get things done which he wanted.  However, a significant portion of this was later overturned by the Courts decisions affirming that the President lacked the legal authority for his actions.  

Reversal of tax cuts

The Tax Cuts and Jobs Act has been Trump’s most significant victory so far, and it has become his signature legislation. Democrats however opposed the bill en masse, and not a single one voted for it. Former (and potentially the next) Speaker of the House Nancy Pelosi, a Democrat, has actually vowed to reverse the tax cuts. Even though the plan is only very vague at the moment, if it were to succeed, it would surely create a drag on the economy and push it into recession sooner than it otherwise would. One of the reasons the Democrats opposed the measure was that it the tax cuts flow disproportionately to the wealth and that it would add to the national debt. However it is almost certain that reversing the tax cuts would not alleviate the debt because a faster, deeper recession would produce less revenue, and Congress has no interest at all in curbing spending. This scenario is implicitly contained in our macro-economic scenario as we consider that mid-term elections are likely to increase pressure on President Trump regarding the debt sustainability issue, triggering a deceleration of growth in 2019 to 2.4% y/y compared with 2.9% y/y in 2018. Indeed, in the wake of recent tax cuts, the degradation of public finances in the US is currently taking place at the same pace as during the subprime crisis. In the end, it is likely to take President Trump leaving office and the emergence of high interest rates to force the US Government to take action on deficit spending. As long as the party is still going on, there is no appetite to deal with this difficult issue even though delaying action makes the problem bigger and harder to solve in the future

More instability in budgetary issues  with repercussions on the equity market

The government is currently funded through the end of September, but if no spending bill is passed by then, the government will shut down, undermining business and consumer confidence.

 

Figure 1  Published Economically Significant Final Rules within 1st year of a Presidential Term

 

Source: RegInfo, Office of Management and Budget

It could also temporarily slow the economy as government employees would go unpaid (they are usually paid retroactively afterwards). In addition, the debt ceiling, which is currently suspended, will in theory be reached on March 1st, 2019 (i.e. the day it is to be reinstated). Typically, the Treasury will be able to avoid the ceiling for some period of time, but eventually it will have to be raised, or the government will have to default on its debt obligations. Normally this results in last minute theatrics and finger pointing with a solution being found minutes before the deadline. However Trump is unpredictable and could do the unthinkable and default on the debt, which would be disastrous for the global economy. A shift of power in Congress, including the influence it could exert on a rebalancing of fiscal policies, is likely to increase uncertainty even more and feed volatility in the equity market. Potential revisions to earnings expectations, in the wake of fiscal back pedaling, is likely to trigger a severe correction of the equity market and a significant depreciation of the Dollar.

Republican Members of Congress will do everything possible to keep the government open and prevent the default on the debt. Deep in their hearts they know that the public would hate this occurring, and would blame them, as the party which controls both houses of Congress and the Presidency, and not the Democrats for the damage. Reigning in President Trump has always been a challenge for Congressional Republicans. Their magic political card is to tell the President that a government shutdown and a debt default would cost the Republicans their Congressional majority and this would mean that the next and possibly the last two years of the Trump Presidency would be miserable for everyone, especially the Commander in Chief.

Re-regulation

One of Trump’s campaign promises was to repeal two existing regulations for every new one created. Although it’s not at all clear if this goal has been achieved, it is true that the administration has stopped some Obama-era regulations that had not yet been implemented. And in the first year the administration approved only 156 regulations compared to over 400 for Bush and over 500 for Obama. In a rare bipartisan move, Congress in 2018 did change part of the Dodd-Frank act to ease restrictions on small and regional banks, and it did so in a bi-partisan effort. Yet again some Democrats are now announcing plans to put back the Dodd-Frank restrictions on some of the larger regional and national banks. That would hurt the economy because those banks would again be constrained in making loans, particularly to small and medium sized business.

Impeachment

Some progressive Democrats have vowed that if they win the House, they will vote to impeach Trump, which would amount to charging him with a “high crime or misdemeanor”.  Others in the party counsel restraint, saying that as evidenced by the Clinton Impeachment

 

Figure 2  US Counties Industry GDP hurt by retaliatory tariffs

 

Source: Wall-Street Journal, Moody’s Analytics (industries impacted); Dave Leip’s Atlas of U.S. Presidential Elections (2016 winners); U.S. Census Bureau (population) .Note: The percentage of gross domestic product in each county is weighted based on the industry share of GDP.

Executive orders and vetoes

If the Democrats take over, the rest of the Trump administration’s plans will be totally de-railed. As a result he will have to borrow from the gamebook of President Obama and other Presidents to use Executive Orders and regulations to achieve his goals, and he will clearly not hesitate to do so. However, even Executive Orders still need funding approval from Congress, providing yet another roadblock. On the other hand the President retains the power to veto any legislation put forth by Congress. That veto can only be over-ridden by a 2/3rds majority vote in both the Senate and the House. The U.S. Constitution does provide an excellent set of checks and balances, but the result could be a completely stagnant government. For example, try as they might during the time when Republicans were in control of one or both houses of Congress during the Obama administration, (2011-2017) they had only modest success in blocking the President. During the Obama years, State Republican Attorney Generals got very good at developing strategies to block regulations once they were adopted. Democrats seemed to have learned from this lesson very well and are doing the same. “I will see you in Court” is a very American way to deal with things you find annoying.

Trade policies

Under the US Constitution, Congress is responsible for deciding on trade agreements, which need to be passed into law. The setting of individual tariffs normally depends on the approval of both the House and the Senate. These kinds of initiatives (trade agreements or tariffs) have traditionally been delegated to the US President, but the Congress keeps its prerogative of accepting or refusing them.

In the current situation, President Trump’s imposition of new tariffs bypassed this approval by utilizing Section 232 of the Trade Act of 1962, which allows the usage of tariffs without Congressional approval on the grounds of national security. Several lawsuits will challenge the President’s authority saying it was designed to deal with real national security issues, and not the importation of expensive German cars. It is possible the Trump administration might be forced to retreat. That being said, the decision to impose tariffs has direct implications on the electorate as evidenced by the map below, which shows that retaliation by China and the EU target President Trump’s voters. In these circumstances, Republican political leaders of these states (often with an important agriculture sector) have recently been less vocal in supporting his protectionist initiatives. In the case of a rebalancing of power in Congress in favor of the Democrats, there could be more support for initiatives which aim at reducing the role of the President in deciding trade policy. In fact on the 11th of July 2018, 39 Republicans and 49 Democrats in the Senate voted for a resolution re-affirming Congress’ role in trade issues.   Already the Europeans have threatened tariff retaliations, and the Chinese are not only doing this but are subjecting

 

all types of US products, including agricultural produce with a short life span, to enhanced inspections which is causing misery for US exporters.

Other considerations

The immigration situation could continue to deteriorate, which would probably favor the Democrats as they are seen to be more humane, particularly in light of the administration’s former policy of separating families caught at the border. A few Republicans could back away from Trump if his immigration and trade policies have even more negative consequences than they already have had. Business and agriculture groups are already complaining about their inability to secure workers.

The fight over the next Supreme Court nominee is likely to be extraordinarily heated and bitter. Ultimately all that’s needed is the 51 votes the Republicans currently have in the Senate, but the Democrats could use the fight to make significant inroads in the election. Trump has already appointed one conservative Judge to the Supreme Court, and another one would give the Court a decidedly conservative orientation for many years to come. Republicans hope that the appointment of conservative Judges will serve as a rallying cry for business owners, and well educated and affluent voters who have been put off by the perceived chaos of the Trump Presidency. They think this issue will bring these less than enthusiastic Republicans back into the party fold.

The Democrats could the issue of Supreme Court Judicial nominations to create fear in the voters that their civil liberties would become under attack. In particular, many Democrats are concerned that the Court could re-visit the landmark Roe vs. Wade decision which legalized abortion in the U.S. Well educated suburban women voters, who usually lean slightly Republican, might be put off by all of this. This was already seen in the Gubernatorial and State legislative elections in Virginia in 2017, where Republicans did much worse than anyone expected. In these elections, Democrats, perhaps motivated by their disdain of the President, came out in much larger numbers than normal, and the important Independent vote, also swung their way.

The Mueller probe into Russia – Trump collusion during the campaign, or possibly rumored reports of his personal financial connection to Russian oligarchs could turn up damning evidence. Thus far the Trump base has stayed with him, but nothing in politics is forever.

Democrats will have to be cautioned about the tendency, for at least of some of them, to move far left on a number of issues where the general electorate disagrees with them. Prominent among them are Medicare for all, the closing down of the Immigration and Customs Enforcement office, and maybe going just a little too far on legalizing, Marijuana and abortion rights.

 

Download The View - July/ August

The View - Growing Out of Sync

pdf | 1.5 MB