The Bush Victory and What It Means

By Scott B. MacDonald

NEW YORK (KWR) One of the most hard-fought elections in several decades is over. President George W. Bush won re-election and Democratic challenger Senator John Kerry lost. Bush gained 274 electoral votes, four more than needed for a win. He also won the popular vote, 51% to 48% for Kerry. In addition, the Republicans expanded their majorities in Congress and hold more than half of the governor mansions. The response in the U.S. corporate bond market was a rally almost across the board.

Those sectors with the most to gain from a Republican victory are the pharmaceutical and health care sectors, defense, energy, basic materials, and any company with asbestos litigation (Halliburton). The last-mentioned is largely because of the loss of Democratic Minority Leader Senator Tom Daschle of South Dakota, who was active in obstructing legislation that sought to undo the litigation mess surrounding asbestos settlements. The expectation is that the Bush victory should provide a positive note for the U.S. corporate bond market in November. Simply stated, the lack of disputed votes and the graciousness of John Kerry in conceding in a timely manner removes a major uncertainty for the market.

Why Did Kerry Lose? Although a lot is said about the division of the United States into two countries (one conservative and deeply religious and the other liberal and secular), that is not a satisfactory answer to why Senator Kerry lost the 2004 presidential elections. A more practical answer is that Kerry failed to persuade enough people that he was more capable of executing the war than Bush.

Iraq dominated all three debates, figured prominently in most of the candidates’ major speeches and certainly was a point of concern among the electorate. Along these lines, Kerry had the problem of appealing to the center by showing that he would win the war, and appealing to the Democratic left by showing that he would end the war. Trapped between the two political groups, he found himself forced to campaign by attacking Bush. In the course of that, he failed (just barely) to persuade the majority that he had a coherent policy. In the end, he could not persuade enough voters that he was better than Bush, even though he might have persuaded them that Bush was bad.

Kerry’s failure to get elected reflects another issue - the decline of the Democratic Party. Despite more people registered as Democrats, the Democratic Party is becoming the minority party in holding political office. It is struggling to regain momentum across the country. Once the dominant player throughout the American south, the party failed to carry any states in that region for Kerry, even with Senator Edwards from North Carolina running as his vice presidential candidate. Yet, even in a heavily Democratic state like New York (which overwhelmingly voted for Kerry), the governor and mayor of its most populous city, are both Republicans. California, another heavily Democratic state, also has a Republican governor.

For any future Democratic candidate to win the White House, considerable thought is required as to what the party represents and where it wants to take the United States. Bill Clinton’s success came from his ability to take to the political center and in some areas clearly borrowed from the Republicans. Kerry and Edwards in many regards harkened back to the old more leftwing Democratic Party. While this guaranteed that they won the nomination process, it hurt them with the political center. As mirrored by the elections results, the old message is not selling. For the Democrats it is time to come up with a new message that sells.

George W. Bush has four more years. He faces challenging environments in both domestic and foreign policy arenas. Approaching the policy arenas he has a strong mandate. Not only has Bush gained in the popular vote since 2000, the Republican Party has greater control over both houses of Congress. This means that Republicans will continue to control important committees in the Congress, including Ways and Means and Banking.

Bush’s economic policy in the second term will focus around three major initiatives - Social Security reform, tort reform and making the earlier round of tax cuts permanent (and making headway on estate taxes). This dovetails with ongoing Bush programs for maintaining a high level of defense spending and reforming the GSEs (Government-Sponsored Enterprises). Trade policy has a protectionist bent, something that is likely to resurface.

Another important issue on the economic policy side is the Federal Reserve. In the short term we do not see any change in Fed policies - at the next FOMC meeting on November 10, we expect rates to go from 1.75% to 2.0%, with one more possible hike by year-end. Although this interest rate cycle is likely to end earlier than most, the Fed is likely to push rates above core inflation.

More importantly, Alan Greenspan is likely to step down at some point during the next Bush administration. This means that the next Fed head is to be selected by a Republican president and Congress. This should have a major impact on regulatory policy and GSEs. As Greenspan has been supportive of reforming the GSEs, we would expect his successor to be like-minded, especially considering that this is a major issue for the chairman of the Senate Banking Committee Richard Shelby, a close Bush ally. Look for more headlines on reforming Fannie Mae and Freddie Mac (actions which are likely to be more bondholder friendly and less equity friendly).

Moving into the next term, the Bush administration expects that economic growth will strengthen as more Americans have more money to spend (because of a smaller tax burden), hence maintaining strong consumer demand. As economic growth picks up, companies will add personnel, bringing down unemployment. At the same time, economic growth will help generate higher tax revenues from corporate America. The combination of these factors will allow the administration to pursue its reforms.

Perhaps the economic scenario of the Bush administration is a little too rosy. The budget deficit is likely to be an obstacle to any new economic policy initiatives. And as spending is not likely to fall, the pressure is on raising revenues. This potentially represents a problem, considering that the administration is still looking for over 4% growth in 2005. We expect real GDP growth in 2005 to be in the 2.5%-3.0% range, largely due to higher oil prices. Consequently, the government will have less money than it thought, which should reduce its ability to launch new initiatives. In addition, there is likely to be growing pressure within the Republican Party to reduce the deficit. Rounding out the picture, the current account balance of payments in massive – close to 6% of GDP. This also represents a challenge to the ability of Bush II to push ahead with more spending.

The other critical area of business facing President Bush in his second term is what to do with Iraq and the war against terrorism. This dominated his first term. Indeed, he responded with a sense of vision that embraced a highly controversial and ambitious policy to make the Middle East a region of democratic governments. U.S. policy, therefore, is based on the holding of elections in Iraq (set for January) and supporting whatever government emerges. Along these lines, Iraq represents much more bloodshed and a testing of U.S. political will. It also means leaning on other governments in the region, such as Iran (with its nuclear ambitions), Syria and Saudi Arabia (home of al-Qaeda’s founder and a majority of the 9/11 terrorists).

U.S. policy also includes the option to strike first, something that has led to considerable friction with a number of Washington’s allies. Yet, Libya was leaned on (starting with the Reagan administration) and eventually surrendered its weapons of mass destruction. Although there is much that can be debated about Bush’s Middle Eastern gambit, if it is successful, he will looked inspired. If he fails, Iraq will be compared to Vietnam, an unpleasant memory in American history.

Presidents going into a second term are searching for their place in history. This is the period when long-term policies already put in place can be sharpened and reinforced. New initiatives can be launched. Bush needs to focus more on the domestic side of policy. Indeed, it can be argued that domestic economic issues - unemployment, the high cost of prescription drugs and the loss of health care insurance - almost cost him the election. The country is divided and needs gracious leadership. It requires a presidential heavy hitter like Ronald Reagan and Franklin Delano Roosevelt, who can restore a sense of domestic purpose and unity. That means dealing with the deficit, reforming Social Security, appointing new Supreme Court justices and restoring a dialogue within the country. Failure to do so will not put Bush with the likes of Reagan and Roosevelt, but in the camp of Rutherford Hayes and Benjamin Harrison, forgotten Republican presidents of the Gilded Age, who presided over growing inequalities in their country. Much is at stake in the next four years.