The Lame Duck President Obama and the Fed Nomination

Today’s commentary

Summary: US President Barack Obama is in his second term in office. And because he cannot run for office again, his decision-making is bound to be different this term than it was in the first term. We are now seeing that in Syria, regarding the NSA scandal and also on the Fed nomination. Below are some thoughts on the implications for policy and markets.

Last night, Larry Summers finally bowed out of contention for the role as nominee for Chair of the Federal Reserve. My sources tell me that as early as May, Larry Summers himself was telling people that he wanted Ben Bernanke’s job. At that time, Janet Yellen’s name was already being bandied about as the next Fed chair. So apparently Summers needed to take action. While he did not openly campaign for the position initially, it is now clear that he was doing significant back channel manoeuvring to secure the nomination.

That Summers has been forced to bow out of contention is a major blow to him because it is an open secret here in DC that he is well known to have coveted the Fed chair job. The fact that a lot of pro-Summers and anti-Yellen press began in August when it was clear that pro-Yellen camp was gaining momentum shows you how much Summers wanted the job. He had taken the back channel approach. But the full-on press assault began only when it became more dicey for Summers.

Now, Larry Summers is out of government, perhaps for good. What does this mean about politics and economic policy in the United States? And what are the implications for the markets?

First, I suggest you read Sober Look’s account of this issue because it highlights why the President has been forced to cede ground on the Fed nomination. Despite having given a full-throated defense of Summers in July, the President finally back-pedalled because the Democratic caucus was in open revolt.

First, the NSA scandal has damaged the President’s standing with his most liberal base and it has galvanized both left- and right-leaning libertarians to work against him. The narrow defeat of the Amash bill in Congress looking to defund the NSA’s spying program despite a full-scale assault against the bill by the Obama Administration is testament to how important the NSA issue is.

Second, even while the NSA issue is still ongoing and new revelations continue to be made, sapping the President of political capital, the Syria issue has become the dominant political issue. And here again, the President has been caught flat-footed, supporting a policy that not only is unpopular with his base but also unpopular with voters as a whole. I believe the President felt forced into the decision because of the red line he drew on chemical weapons a year ago. And rather than back down and face the humiliation of such a prominent flip flop on national defense, something particularly problematic for Democrats who are always labelled as weak on defense, he decided to look to authorize military strikes. When the British government’s attempt to back Obama failed, it was a double blow for the President because he lost America’s key wartime ally, one that is vitally important in moving US political opinion. Without Britain at America’s side, a strike on Syria would lose legitimacy and become very unpopular with voters. Moreover, that the British had to seek Parliamentary approval and face rejection made Obama take the fateful decision of doing the same, against all of his key advisors counsel. Eventually it became clear the President was going to suffer a crushing defeat. However, the Russians extricated him from this by brokering a diplomatic solution which we are now pursuing. Nonetheless, the damage politically has been done.

Third, the battle over the Fed chair has also been problematic for the President with his base. In late July I outlined why Janet Yellen should get the nomination and I said that the Fed nomination battle is disastrous for Obama because “[t]here are only three possibilities for why passing over Yellen for Summers makes sense and these are all non-political reasons. First, Summers is more anti-regulatory and would be more likely to go easy on the banks. Second, Summers is a known quantity, an insider if you will, and Obama likes to take an insular approach, selecting people he knows well for key jobs. Third, some sort of gender bias is at work.” None of these reasons resonate with Obama’s base, quite the opposite. And given the other two damaging issues, this is a big, big problem. Thus, Summers withdrew his name from contention in order to spare the President more humiliation.

My view here is that President Obama, as a lame duck, now feels freer to pursue his own course. The reason he has made this series of costly political decisions is because he doesn’t have to get re-elected and so he feels freer to set an agenda closer to his personal ideological preferences. What we are seeing now on national defense, civil liberties and on monetary policy is much close to the real Barack Obama than anything we have seen thus far. I believe the President will continue to freelance politically. And that makes policy much less predictable in this second term. The President will not necessarily make decisions that are politically astute. Rather, he may make politically difficult decisions because they are closer to his ideological predisposition.

On monetary and fiscal policy, I believe the President is more hawkish than people like Yellen or Romer. He believes in deficit reduction and while, like Summers, he probably also believes fiscal is more important than monetary policy now, that won’t mean he is going to turn on the fiscal taps. because of his hawkishness and because he still wants to make overtures on fiscal policy toward the Republicans. What this means is that President Obama is likely to be tighter on both fiscal and monetary policy than many anticipate. I have been saying this since October of last year when Obama was running against Romney.

And because corporate profits are very much dependent on fiscal largesse due to the sectoral balances, I believe this is negative for profits and therefore potentially negative for shares – in the absence of multiple expansion or increased consumer spending. In short, I believe a more hawkish Obama will catch the markets by surprise in terms of fiscal policy and despite the negative political implications, it also may pull him away from selecting Yellen, who is seen as a monetary dove.