In the past couple months I have seen dozens of articles paralleling the 2012 election to the 1912 election. Conservatives are trying to paint Obama as a Woodrow Wilson 2.0, a man known for government growth in the Progressive Era and creating the precursor to the United Nations. Liberals point out that Wilson implemented civil service reform and cleaned up corruption in the government. Either way, the political parallel is interesting, but not relevant to our economic situation. The more apt parallels might be to 1952 or 1972.
Like 2012, 1952 was an election year in an economically volatile period with an ongoing war abroad. Economic policy in this period was heavily driven by the ongoing conflict between the Fed and Treasury. In the late 1940s and early 1950s, the Truman administration heavily pressured the Fed to maintain WWII level low interest rates first to stimulate the economy, and then to finance the Korean War. The result was 14% inflation in 1947 and 8% inflation in 1948 followed by rising unemployment in 1949. But, due to pressure from the White House and Treasury, the Fed was unable to act to control inflation (despite the oft-lauded 1951 Accord) until Dwight Eisenhower won the Presidency in 1952 and installed Fed friendly personnel at the Treasury when he entered office in 1953. The result was higher interest rates that pushed the country into a brief recession, but allowed the second half of the 1950s to be the most prosperous period in American history.
So, this story leads us to believe that if we just elect Mitt Romney he will free the Fed to fight inflation and the economy will be saved, right? Wrong. Circumstances today are very different. The Fed is not under pressure from the Obama administration the way they were under the Truman administration. Moreover, high unemployment in that period was 5.9% in 1949, versus 8.1% today. So, the only parallel seems to be that under Eisenhower the Fed fought inflation and under a Romney administration, a new Fed Chairman would surely be appointed in 2014 with the goal of fighting inflation, even if it remains below 2%, as it is today.
Given the current polling numbers, it is likely that we will see another Obama term. The question is whether or not this will look like the 1972 reelection of Richard Nixon. Leaving aside Richard Nixon's politics and reputation issues, it is important to point out that 1972 is a canonical example of a President interfering in monetary affairs. Nixon is widely known to have pressured Fed Chairman Arthur Burns to keep rates low to continue economic growth through the election. Burns essentially complied and the result was rampant inflation throughout the remainder of the 1970s.
So, is Obama pressuring Bernanke to not just keep rates low, but continue pumping liquidity into the system? Thus far, we have seen no evidence of that type of political pressure. If anything, the fact that hawkish Minneapolis Fed President Kocherlakota recently suggested continued low rates until unemployment is below 5.5% implies that the either the entire Federal Reserve system is corrupted by politics (unlikely, since the regional bank Presidents are selected by private boards) or the data is overwhelmingly clear that low rates continue to be necessary.
In both 1952 and 1972 the United States was at war and running deficits to fight the ongoing conflicts in Korea and Vietnam. Today the U.S. is still at war in Afghanistan, and although that war (and the Iraq war) has heavily contributed to our enormous national debt, it is not the driving cause of our current deficits. Some might argue that the U.S. is fighting a currency war with China, and while this is not preposterous, it is also not the exclusive drive of modern monetary policy.
The truth is that the 2012 Fed does not look like it did in 1952 or 1972, it is far more independent. So, while we can call into question current Fed policies, it is noteworthy that Fed officials are trying to act in the best interest of the economy, not in a particular political interest. This leads to the conclusion that the current stimulus policies are necessary as a result of weak economic fundamentals, not as a result of political pressure.
Fed action in light of weak market fundamentals calls into question why the equity markets are rallying if the economy is so weak. The only answer seems to be that some investors decided that the Fed must be divorced from economic reality and therefore acting politically. Other investors saw these players moving into the market and herd mentality took over. The result was an unwarranted rise in equity markets that began to correct last week as investors realized that Fed stimulus is not a bull market rallying cry, but a sign of serious weakness in the economy. Look for equity markets to remain soft through October until the Halloween indicator kicks in and we start our annual end-of-year rally.