- In a bad economy, the challenger should be sitting pretty.
- The history of recessions and oil shocks suggest, however, that the incumbent will win.
- Obama will probably beat Romney in November.
Upon the king! let us our lives, our souls,
Our debts, our careful wives,
Our children and our sins lay on the king!
We must bear all. O hard condition,
Twin-born with greatness, subject to the breath
Of every fool, whose sense no more can feel
But his own wringing!
--Shakespeare's Henry V
It's the economy, stupid.
My background is in political theory, and I first became interested in economics, markets, and the question of money as my understanding of how economic relationships impacted culture and political order expanded. This was a somewhat difficult concept to grasp, because we instinctively blame or praise not merely the general political order (eg, free market vs socialist) or the government in power for prosperity or decline, but specifically the chief executive.
Carter is a byword for stagflation. Reagan for renewal. Clinton for balanced budgets and growth, and so on. Of course, we could go back to Hoover and FDR and Coolidge, as well, although interestingly, I cannot think of a president before the establishment of the Fed whose legacy has been chiefly economic, unless one were to count Jackson and his opposition to a national bank.
There seems to be some kind of psychological need to place our fortune, good or ill, "upon the king", even in modern republics. My own suspicion is that we don't have any clear idea of why our economy behaves the way it does and so we must find a head upon which we can "lay our sins".
So, now we are three months out from another presidential election. And, the world economy could not be more worrisome. In the US, unemployment is high, growth is meager, and nobody really seems to know what's going to happen next. Will Europe implode? Will China collapse? Will inflation burn us to death? Or will deflation suffocate us? Nothing seems impossible.
In theory, Romney should be sitting pretty, and yet somehow he doesn't seem to be able to get any traction against the President. It is whispered that he is a "wimp".
The Republican party will likely never forgive itself for losing such an "easy" election as this. Rife unemployment, a bloated state, mountains of debt, a president who is not especially keen on entrepreneurship. The Republicans have been pitched a softball.
My bet is that they cannot win the White House, however.
Back in June, I wrote that historically there have been two signals of approaching oil shocks, namely "Leeb shocks" (i.e., an 80% y/y increase in crude oil prices): one is a jump in the gold/oil ratio, and the other is a compression of the yield curve below the 1.0 level.
At that time, I wrote that the gold/oil ratio suggested a possible Leeb shock sometime this summer, but that the yield curve had not confirmed this.
The flattening of the yield curve typically occurs about sixteen months before an oil shock, so if the spread on Treasuries should narrow between now and the election, which is hard to imagine, it wouldn't make much difference with respect to the phenomena I am talking about here.
In the post-Bretton Woods era, no party that has governed during a Leeb shock preceded by a suppression of the yield curve below the 1.0 level has ever won a presidential election. And no party that has presided without such a shock occurring has ever lost.
Although there was a Leeb shock in 2009-2010, it was not preceded by a compressed yield curve. The 2008 shock during the end of the Bush presidency, however, was preceded by an inverted curve.
(source: St Louis Fed)
Rather surprisingly, this was even true for Gerald Ford, who took over for Nixon while oil prices remained in a state of shock.
The second Nixon administration, the Ford administration, the Carter administration, Bush Sr's administration, Clinton's second administration, and Bush Jr's second administration all experienced oil shocks preceded by compressed yield curves. They or their successors (Gore and McCain) all lost.
Reagan had an oil shock in his second term, but much like Obama in 2009, this was not preceded by a narrow spread in Treasury yields.
Reagan and Clinton each had yield curves below the 1.0 level in their first terms, but neither were followed by oil shocks.
If this is more than coincidence, the explanation is probably that voters can endure a good deal of economic pain, but they do not like uncertainty exacerbated by volatility. Indeed, if there is any surprise this election year, it might be just how docile the electorate is despite half a decade of high unemployment and expanding debt.
At present, Intrade has President Obama's chances at 58%. Seems like a fair bet.
Additional disclosure: I am long October WTI. I am short gold, Dow and S&P September futures, as well as AUDCHF and AUDJPY.