John Kerry

Barring miracle or mishap, John Kerry will shortly be rubber-stamped as the Democratic candidate for the 2004 elections. But what impact would President Kerry have on bondholders and the wider economic community? Dalia Fahmy reports

Senator John Kerry, the Democrats’ best hope for reclaiming the White House in November, has two words for economic sentimentalists: Bill Clinton. Alluding to him frequently when discussing the economy, he conjures up images of an industrious wonderland teeming with workers and stock market experts, where government coffers overflow and money seems to grow on trees.

“If you liked the first eight years of Bill Clinton,” Kerry recently said in a televised interview, invoking President George W. Bush’s predecessor who presided over the longest economic expansion in history, “you’re going to love the first four years of John Kerry.”

Kerry wants a piece of Clinton’s pristine economic record: gross domestic product growth averaging 3.75% over two terms, unemployment at its lowest in 30 years and a stock market which showered even the most amateurish investor with easy riches.

As if hoping to recreate history, the four-term Massachusetts senator has built his campaign on the pillars which defined Clinton’s economic reign—jobs growth and fiscal discipline—and hired many of Clinton’s former staff as advisers. Roger Altman, deputy treasury secretary from 1993–1994, leads Kerry’s policy team, which includes Gene Sperling, former chair of the National Economic Council, and Jason Furman, a 33-year-old Harvard economist who worked under Sperling in the Clinton administration. Laura D’Andrea Tyson, former chair of the White House Council of Economic Advisers, and Alan Blinder, former vice-chairman of the Federal Reserve, supply their opinion on a regular basis, as do dozens of other powerful number-crunchers.

“These are the Democrats united, trying to get back into office,” Blinder says. “We are proud, not ashamed about the record of the Clinton economy.”

Kerry seems to have convinced some that he can duplicate the fortuitous blend of fiscal discipline and economic growth known as Clintonomics. According to a recent nationwide poll by the Los Angeles Times, 47% of respondents said the 60-year-old Vietnam veteran could best protect the financial interests of average Americans, while 34% favored Bush. With Democrats accusing Bush of letting almost three million jobs vanish under his watch and of turning a $200 billion budget surplus into a $500 billion deficit, Kerry’s message was cut out for him long before he started campaigning.

Wall Street, however, dances to a different tune. Equity markets shudder at Kerry’s perceived protectionist bent and unfriendliness toward businesses. His promises to close corporate tax loopholes, curb outsourcing of jobs overseas, and crack down on health care particularly have investors worried. Research firms have begun publishing lists of sectors that might suffer under Kerry; energy, defense and auto manufacturers top the list. One strategist even went so far as to predict a 10–15% drop in the Dow Jones Industrial Average if Kerry were elected.

However, credit markets, sharing Kerry’s fixation on the budget, are more forgiving and even delighted with his pledge to halve the deficit in four years. But they also fret that his plans to spend billions of dollars on education, health care and job creation will undermine fiscal discipline.

“Nobody has come clean with the American public about the ‘free lunch’ element to fiscal policy,” says Lehman Brothers chief economist Ethan Harris. “The Bush administration has told us we can have it all: that we can have big tax cuts, big spending on homeland and conventional defense and no restraint on other spending programs. It just doesn’t add up. The Kerry camp is telling us that we can have small tax increases and big spending increases, and still reduce the deficit. That doesn’t add up either.”

Economic strategy

John Kerry’s economic plan revolves around three key promises: to cut taxes for the middle class, halve the budget deficit and create 10 million jobs in four years. To achieve his goals, Kerry has proposed reinstating the ‘pay-as-you-go’ system of the 1990s which limits discretionary government spending and requires tax cuts and new outlays to be funded by tax hikes or program reductions in other areas. This rule expired in 2002 and lawmakers are currently debating a renewal.

“My budget plan pays for my proposals,” Kerry said in one of his earliest economic speeches held at Georgetown University in April. “As I put forward new ideas for a stronger, better, more prosperous America, I will state in specific terms how to finance them without raising the deficit or middle-class taxes.”

Kerry hopes that by keeping government spending steady over the next four years, the budget deficit will automatically shrink as the economy picks up and businesses and families start paying more taxes. But the question is whether Kerry can really curb spending.

“There’s a real issue as to how to make these numbers work. That’s the challenge for the Kerry administration,” says John Silvia, chief economist at Wachovia Securities. “Where are you going to cut spending if you’re going to increase entitlements in all these areas like education and health which are very expensive?”

Under Kerry’s 10-year plan, $653 billion would go toward tax credits and subsidies in health care, $200 billion toward college tax credits and an education trust fund, and billions more toward a 5% corporate tax cut. Investors are particularly worried about the size of his health-care package, by far his biggest expense, as he tries to make coverage virtually universal by 2014.

To fund the proposed corporate tax cut, which would lower the tax rate for companies to an average 33.25% from the current 35%, Kerry promises to end the practice of tax deferral on foreign income. Currently, companies can delay tax payments on income earned abroad, as long as the earnings remain on foreign soil. Many businesses keep their profits overseas indefinitely and avoid paying taxes altogether, while others repatriate their money during unprofitable years when much of it can be written off. Kerry says the government could generate $12 billion a year by closing this loophole, allowing him to cut taxes for “99% of companies and small businesses”.

“If a company is torn between creating jobs here or overseas, we now have a tax code that tells you to go overseas. That makes no sense, and if I am President, that will end,” he told a group of supporters in Detroit, Michigan.

Intended to discourage companies from outsourcing jobs, the plans to cancel the tax deferral have angered business leaders. “With the US economy now climbing out of the recession, it is imperative that policymakers avoid high-risk, isolationist policies that would choke off the recovery,” said John Castellani, president of the Business Roundtable, in a response to Kerry’s proposal.

The jobs crisis has been one of Kerry’s most prominent talking points so far, and his promise of creating 10 million jobs fits neatly into headlines. But with the recent uptick in monthly employment figures and an economy poised for continued recovery, experts say Kerry may end up taking credit for an improvement he inherited from the Bush administration.

“Ten million jobs isn’t unreasonable over four years, particularly given that when Kerry gets into office, jobs are going to be created at a pretty rapid clip simply because we’ll be coming out of the recession,” says Gus Faucher, senior economist at Economy.com. “But I don’t think his economic policies would have much to do with it.”

Blinder, one of Kerry’s advisors and director of economic policy studies at Princeton, agrees that a jobs recovery may already be in the works, but argues that sound decisions can reinforce underlying trends. “It is true that in almost any economic structure and certainly in ours, most of what goes on is coming out of the private sector and is going to be influenced only in minor ways by government policies,” he says. “But that doesn’t mean the policies are useless, because changes on the margin can be very important. If we could change the amount of employment in the economy for example by 1%, that’s a huge achievement.”

A friend to bond investors?

Bond markets are beginning to follow the Bush and Kerry campaigns with interest, trying to decide who is more committed to clamping down on government spending. Fixed-income investors usually prefer thrifty leaders who minimize federal borrowing, thereby keeping bonds in strong demand. Although Democrats have traditionally been labeled as heavy taxers and lavish spenders, Clinton helped recast the party’s image with centrist economic policies. During his administration, the budget swung from a $290 billion deficit to a $210 billion surplus, sharply reducing the government’s borrowing needs and allowing it to stop issuing 30-year Treasury bonds.

“The bond market will be a little more comfortable with Kerry because Kerry seems to have a louder voice when it comes to cutting the deficit. Which is ironic because the Democrats don’t have a historical reputation for lowering the budget deficit,” says Anthony Chan, chief economist at Banc One Investment Advisors, where he helps manage about $187 billion in fixed-income and equity assets. “The Democrats, at least since Clinton, seem to have a better reputation for lowering the budget deficit.”

Even if Kerry turns out to be a bigger spender than bond markets would like, the prospect of a Democratic president pitted against a Republican Congress in a legislative gridlock puts some investors at ease: Republicans will have a hard time making the 2001 tax cuts permanent, and Kerry will have to fight for every penny he wants to spend on social programs.

“One thing the bond markets might look forward to, beyond the general notion of gridlock—you know, ‘stop them before they spend again’—is a lot of the Bush tax cuts trigger off over the next five to 10 years,” says Chuck Gabriel, political economist at Prudential Securities. “You could probably save yourself close to a trillion dollars in the next decade if you could just get a bit more gridlock on the tax cut.” Gabriel adds that psychologically, just the perception that Kerry may have won on a fiscally responsible platform will help soothe market concerns about the deficit.

But even the toughest budget hawk can’t stop the widely anticipated rise in interest rates. As the economy continues to recover, the Fed is expected to tighten monetary policy, and Lehman Brothers’ Harris predicts that 10-year Treasury yields will rise to 4.75% by the end of the year, from the current 4.19%.

If the bond market seems to lean slightly in favor of Kerry, the stock market wholeheartedly opposes him. Businesses are wary of Democrats, who traditionally side with unions; one of Kerry’s closest economic advisers is Gerald Shea, a senior executive at the AFL-CIO, the nation’s largest association of unions. A recent poll by Duke University pegged the number of chief financial officers who believe Bush would be better for economic growth at 64%, and those who consider him better for stock markets at 58%, while Kerry scored just 12% on both questions.

It is no surprise that Wall Street contributions so far, as in the past, heavily favor the Republican campaign. Investment firms and commercial banks have poured $8.1 million into President Bush’s reelection so far, and just $1.6 million into Senator Kerry’s, according to the non-partisan Center For Responsive Politics which compiles fundraising data.

“[Bush] has really developed his relationship with Wall Street, to the extent that financial companies are strongly supporting Bush in this election,” says Steven Weiss of the Center for Responsive Politics. “He has been to Wall Street many times to campaign, and Stan O’Neill, head of Merrill Lynch, is one of Bush’s top fund raisers.”

The President’s list of top donors reads like a Who’s Who of Wall Street: Merrill Lynch with $0.5 million, UBS with $0.4 million, Lehman Brothers, Goldman Sachs and Credit Suisse First Boston with about $0.3 million each, and Morgan Stanley, Bear Stearns and Citigroup with $0.2 million each.

By contrast, Kerry’s biggest contributors from Wall Street are Citigroup with $86,750, Goldman Sachs with $73,750, FleetBoston Financial with $49,250, UBS Americas with $43,800 and Morgan Stanley with $42,500, according to the Center. With three months left before the Democratic National Convention, where Kerry is expected to receive the formal party nomination, this gap is only expected to widen further.

Inconsistent record

Once Kerry secures the official support of his party, election fever is expected to heat up even more, and experts say he will face many challenges in the months leading up to November. One of the main criticisms he will have to deflect is that he often changes his mind, not following through on policy decisions.

“There’s no consistency in his voting record over the years,” says Chris Edwards, director of fiscal policy studies at the Cato Institute, a conservative think tank which advocates minimal government involvement in economic affairs. “He will just latch on to things that have superficial political appeal. He hasn’t been consistently for or against corporate America, for or against other types of policies. He was for President Bush’s No Child Left Behind education policy, but now he says it’s horrible.”

Kerry’s supporters disagree. Blinder says Kerry put jobs creation and fiscal discipline at the top of his agenda very early on, and has stuck to it. “Traditionally, the Democratic party has always—even before Roosevelt—been the party of job creation. There’s nothing startling about that,” he says, referring to FDR’s New Deal economic program which helped pull the country out of a massive recession in the 1930s. And fiscal discipline “has always been on John Kerry’s mind as a senator, and certainly on his mind as a candidate”.

Ron Rosenblith, who befriended Kerry when they were both protesting the Vietnam War and has worked for him as a fundraiser and campaign consultant, says Kerry’s fastidiousness is sometimes mistaken for indecision.

“I see a guy who’s held the same consistent values for the past 30 plus years that I’ve known him,” says Rosenblith. “He sees the complexity and nuances in a lot of issues that frequently get dismissed and ignored.”

Some argue that Kerry’s voting record matters less than his ability, if elected, to prevail over a Republican Senate and House of Representatives, and to lead a team of advisers who can turn the economic recovery into another boom. But Prudential’s Gabriel says guiding the country to prosperity will require more than a smart set of economists.

“Kerry might be trying to surround himself with sharp young economic advisers seemingly with new ideas, even centrist-leaning ideas, just to connote a Clintonesque economic posture. But I think that his difficulty is going to be to propose something that is really going to make a difference,” says Gabriel. “I don’t think Kerry is as politically gifted as Clinton was, and I think most people believe Clinton and his economic team presided over a virtuous cycle that was under way.”

If elected, Kerry’s challenge will be to deliver on his lofty economic promises in view of an impending demographic crisis, economists say. In 2008, the so-called baby boomer generation of Americans born after World War II begins to retire and qualify for government pensions and health insurance, squeezing the federal budget—and the already woefully underfunded social security accounts—like never before. By 2030, America’s demographic makeup will resemble Florida’s, where almost 20% of the population is over 65, says Harris.

“The next four years is still a honeymoon before the baby boomer disaster hits the fan,” says Cato’s Edwards. “It’s really the next president after this one that will have a tough job.”

Lehman’s Harris says the opportunity to deal with the social security crisis is slowly slipping away, and neither party seems prepared to tackle it. “Because of the way the election debate is framing up, and it’s all about sound bites and cute ideas, there is no vision from either party. Nobody wants to come out and say wait a minute, we have some painful decisions to make here.”

Standing under the stage lights last March, facing several hundred supporters at Wayne State University in Detroit and talking about the future of America’s economy, the Democrats’ presumptive presidential candidate seemed stuck in the past. Like Clinton, he had chosen the Midwestern factory hub to unveil the first installment of his economic plan. Like Clinton, he played up jobs growth, fiscal discipline and tax reform. Although Kerry did not mention Clinton by name in that speech, he did so several times at his second economic address in Washington DC a month later, promising to restore America to its prosperity of the 1990s.

Kerry’s economic aides reinforce the comparison often, insisting that the country is ready for another round of Clintonomics. But how can they be so sure that those policies will work again?

In the mind of Kerry adviser Jason Furman, the answer is clear. “We know they’ll work because we’ve seen them work in the past,” he says. “Bill Clinton put into place fiscal discipline, which restored confidence and created jobs. He invested in people which helped to ensure that not just people at the top saw their incomes go up but that incomes went up across the board. He cut taxes for middle-class families. This is a proven economic strategy, and we’re confident it can work again.”