Separate Politics and Economics at Your Own Peril

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Many people understand politics and economics to be two different disciplines.  I remember in graduate school more than two decades ago, many colleagues and professors operationally defined political economy as how politics, by which they meant the state, screws up economics. 

I spoke at the Fixed Income Leaders Summit earlier this week and teased that many seemed to think that politics comes from the ancient Greek “poly” meaning many and “tics” meaning bloodsucking parasites.  It, of course, is not true.

Many people understand politics and economics to be two different disciplines.  I remember in graduate school more than two decades ago, many colleagues and professors operationally defined political economy as how politics, by which they meant the state, screws up economics. 

I spoke at the Fixed Income Leaders Summit earlier this week and teased that many seemed to think that politics comes from the ancient Greek “poly” meaning many and “tics” meaning bloodsucking parasites.  It, of course, is not true.

The greater pillars of economic thinking like Riccardo, Smith, and Smith, thought they were doing “political economy.”  It is only with the success the positivists that modern university that the disciple is bifurcated.  It serves the (neo) liberal ideology which pretends that the market is a force of nature and self-regulating (to a large extent). 

Few can draw the linkages between the economic crisis and the rise of nationalism throughout the high-income countries.  A good corrective is a review of Karl Polanyi’s The Great Transformation.  Polanyi shows that there are two moves.

The move toward a market economy and then a political push back.  The Reagan-Thatcher era of deregulation removing many of the safeguards that were established after the Great Depression helped facilitate the Great Financial Crisis. 

From a slightly different perspective, consider that the type of capitalism that emerged after the stagflation of the 1970s, was predicated on the defeat of working class organizations, like labor unions.  This allowed a greater share of productivity gains to go to profits instead of wages.

Capital’s victory was its downfall.  It took such a large share of the pie that it undermined aggregate demand.  It produced such a disparity of wealth and income that it insulted a basic sense of fairness.  The Occupy Movement may have been an initial cry of most privileged young people who realized that their chances of maintaining the class status that their parents had achieved, or improving upon it, were dimming. 

The nationalist movement throughout the high-income world is a specific response to the economic challenges, and the inability of the political and economic elite to deliver rising living standards. High levels of unemployment and underemployment, coupled with the numerous scandals, has undermined the political center.  At the same time, the end of the Cold War took away a major differential between key political parties.  Ironically, the demise of the Soviet Union reduced the traditional political space in the US and especially in Europe.  

There can be only three broad relationships between politics and economics.  The realists and nationalist that can be traced back to at least Machiavelli argue that politics is more important than economics.  Traditional liberals (not the conventional use of the term in the US) see economics as more important than politics. 

Isn’t that the basis for the claim that two countries with McDonald’s don’t go to war with each other (and the couple of exceptions demonstrate the rule)?  Isn’t it also the basis of the distinction between authoritarian and totalitarian regimes, where the former as a market economy but undemocratic politics, while the latter has a command economy and undemocratic politics.  It led some to (erroneously) conclude that authoritarian regimes (think Chile, for example) could reform while the Soviet bloc could not. 

The third possibility is that politics and economics are opposite sides of the same coin.  They are not two opposite realms.  Even for analytic purposes, they are hard to separate.  Consider the definition of politics by Harold Laswell, regarded as one of the fathers of modern political science:  Who gets what when and how.  Doesn’t that sound an awful lot like economics? 

The UK referendum on June 23 is the most immediate political event.  The opinion polls remain tight.  A couple of large bookmakers in London have tightened up their odds. The events markets also show the lead of the “remain” camp has narrowed.  Some observers suggest that the UEFA Euro2016 football championship that begins today will strengthen nationalist sentiment, which favors Brexit.  We’ll have to see what happens when England plays Wales next week. 

Brexit fears are thought to be a force weighing on bond yields, especially in Germany, Switzerland, Japan and the US.  In the currency market, some speculators have been selling euros for Swiss francs, and this may be a factor as well in supporting the yen.  Investors have been buying sterling puts and in so doing, have lifted implied volatility (one-month) to the highest since the Great Financial Crisis, while the premium being paid for puts (over calls) is at a record level. 

On June 26, a few days after the UK referendum, Spain is having a “do-over” election.  The December contest failed to produce a new government as the old two-party system broke down.  The polls suggest that there has not been much change over the past six months.  Rajoy’s PP is drawing a little more than 29% of the vote, which is about 0.5% more than it garnered in December.  This may secure the party 118-121 of the 350-seat parliament.  The Socialists appear to have slipped slightly to 21.2% from 22% in December.  This may be worth 78-80 seats. 

The two new parties are doing a bit better.  The centrist Ciudadanos is polling around 14.6%, up from a little below 14% in December.  Podemos looks to be the biggest winner since the December election.  It supported by about 25.3% of the voters, up from 24.3% in December.  Ciudadanos may secure 38-39 seats while Podemos is tracking a little more than 90 seats.  PredictIt is showing that while the market continues to show Rajoy favored to serve another terms as Prime Minister, the odds have been trending lower.  We suspect that if the poll indications are close to the money, that sacrificing Rajoy could be the easiest way to form a coalition government. 

Another political development is the declaration of German President Gauck that he will not seek another term.  The 76-year old former pastor from East Germany said he was concerned about his vitality for another term, much to the dismay of Chancellor Merkel.  Gauck was not Merkel’s first choice.  The German President is not elected by popular vote but by a special federal assembly. 

Although it is largely a ceremonial position, Gauck used it as a bit of a bully pulpit, pushing for a larger role for the German military, and was critical of Merkel’s immigration/refugee policy and the deal with Turkey.  However, the problem for Merkel is that she may have to spend increasingly scarce political capital.  The presidential selection is inseparable for next year’s national election as parties jockey for position. 

Indeed, her weakened political position may see the CDU’s sister party CSU (Bavaria) put forward its own candidate.  Merkel’s national coalition partner the SPD will most likely push of its candidate.  There had been some talk that Merkel would shake up her cabinet ahead of next year’s election.  Her candidate could facilitate that if the CDU would put forward a candidate that is currently in the cabinet.

While the controversial Finance Minister Schaeuble may be an interesting candidate, his supporters would likely want him to remain in the cabinet as an important check. Germany’s Foreign Minister Steinmeier has also been touted.  Reports suggest that the Bundestag Speaker Lammert may have an early lead. 

Here is the larger challenge.  The CDU/CSU is polling about 30%, and the SPD are drawing a little less than 20%.  These are record low indications.  It is possible that assuming Merkel does see a fourth term; another party might be needed in the coalition.  That leaves the Greens as the most likely choice, but that does not sit well with the CDU/CSU. 

Is there an alternative?  Recent polls suggest that FDP is making a quiet comeback.  It was a CDU ally until the Greek crisis.  However, with new leadership and new issues, including immigration, is appears poised to win parliamentary representation again.  Merkel, the tactician, might be able to use the German president post to help the FDP. 

Another important political development is that Clinton has secured the Democratic Party’s nomination.  Next month she will officially become the first woman to head a major party’s ticket. The vast majority of polls point to Clinton winning the national contest in December. The Electoral College map suggests she may do better than Obama in 2012. 

Sanders has not officially conceded, but he is expected to after the last primary (Washington, DC on June 14).  Despite the apparent acrimony, the Democratic Party looks more unified than the Republicans.  However, to secure the enthusiasm of Sanders supporters, Clinton may have to make several concessions, including parts of the party platform.   

The PredictIt events market continues to show that Elizabeth Warren is the favored vice-presidential candidate.  Even though her 30 cents (to win $1.00) leads the other potential candidates and is a new high for Warren, we suspect that Clinton will not pick her.  She would not add very much to the ticket.

Clinton appears to be drawing more Hispanic and African-American vote than Obama did in 2012.  That suggests a young male Hispanic might not bring as much to the ticket as it may have appeared earlier in the process. We think a white male senator from a swing state like Virginia makes sense. 

Meanwhile, many Republican officials have been critical of Trump’s statements about the nationality and religion of judges.  It is difficult to get a strong sense of who would serve with Trump.  PredictIt has the Jeff Sessions, a Republican Senator for Alabama, moving past Gingrich as the favorite, but at a soft 27 cents.  Gingrich has slipped to 17 cents from 25 cents earlier this month. Joni Ernst, a first-term Senator from Iowa, is in third place at 12 cents.

Politics and Economics is republished with permission from Marc to Market

About Marc Chandler PRO INVESTOR

Head of Global Currency Strategy at Brown Brothers Harriman.