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The US Economy and its Impact on the Election Campaign

Author: Roger M. Kubarych
June 30, 2004
Council on Foreign Relations


Halfway through 2004 two questions are on the minds of investors. First, how is the US economy doing? Second, who will benefit from the economic issue by election day in November, President Bush or his challenger Senator Kerry?

The US economy is doing fine, growing about 4% per annum with good momentum for the months ahead. Not every region and industry nor every American worker is gaining ground. For example, auto production has recently fallen. But the overall trend is favorable.

Employment is expanding at an impressive 300,000 per month. Personal incomes are nearly 6% per annum higher so far this year. The median price of a single family home on the resale market is up 10% from June 2003. That alone adds almost $1,500 per month, or 35%, to the potential resources the average homeowner can use to finance consumption. Rising home values make a bigger contribution than stock prices to the wealth of all but the top 5% of wage earners. Not surprisingly, consumer confidence is again pointed upward. So Bush is likely to benefit.

The main dark spot on this otherwise rosy picture is the pick-up in inflation that is occurring. Inflation, as measured by the personal consumption deflator excluding food and energy (the obscure index that the Fed favors), is running at 2.5% per annum. That is double the rate the Fed itself had predicted just four months ago. Include food and energy, and consumer inflation is twice as fast. Rising inflation means higher interest rates, which most people dread.

Another factor increases the vulnerability of the US financial markets to unforeseen shocks. It is the combination of a huge Federal Government budget deficit, well over $400 billion this year, and an escalating international trade deficit. Both are being financed primarily by massive purchases of the US Treasury securities by Asian central banks and governments, notably Japan. Without those purchases, US interest rates would have to be much higher to induce private investors to acquire the Treasury’s debt.

Financing the US external deficit

Q1 2004

$ billions

Current-account deficit


Net Direct Investment


Total Net External Financing Needs


financed by:


Net private portfolio investments


Net short-term capital flows


Foreign official assets in the United States


Financing the US government deficit

$ billions

Q1 2004


US Treasury borrowing need



financed by:



Domestic investors



Foreign private investors



Foreign official institutions



Some in the Bush administration say budget deficits don’t matter and that trade deficits are principally the reflection of weak economies abroad. Both are overstatements. The Kerry campaign is already hard at work trying to develop an economic program that will assure independent voters in the pivotal Great Lakes states of Michigan, Ohio, Pennsylvania and Wisconsin that a President Kerry would be better at dealing with both deficits. That will not be an easy task, as demonstrated in the latest public opinion polls.

There are at least a dozen reputable polling services that track voter intentions. Right now, some show Kerry ahead, some show Bush taking a slim lead, but most say the race is deadlocked. When asked who would be better at managing the US economy, respondents in many surveys answer Kerry, but Bush has moved ahead on this issue in a few polls lately.

More worrisome for the Kerry camp, swing voters do not seem entirely impressed by Kerry’s economics. When likely voters are asked why they have a favorable impression of Kerry, fewer than 10% cite his economic plan as the reason. Either they don’t know what it is or don’t find it especially compelling. So Kerry has his work cut out for him.

Many experts believe his only chance of overcoming Bush’s strengths as the incumbent is to convince independent voters that the Bush administration has cut taxes too much and for the wrong people, causing larger budget deficits, and that Bush has mismanaged US relations with key trading partners in Asia, especially China, leading to a growing trade deficit. The message is that Kerry would raise taxes and lower the value of the dollar in the foreign currency markets.

In November voters will decide whether they prefer higher taxes and a lower dollar to Bush deficits. That would appear to be essential if Kerry is to pull off an upset.

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