Avoiding the Curse of the New President: Recession

As we get closer to the end of 2000, I can sense investors starting to worry about 2001. Next year can't be as bad as this one has been, can it? Technology stocks will do better in 2001, right? The Dow Jones Industrials and the S&P 500 will both finish solidly in the black. Please?

I do think 2001 will be better. Honestly. By the middle of the year or so, I'm almost certain that we will have wrung out all of the excess in stock prices -- and then some. Companies that stumbled in the second or third quarters of 2000 will start going up against easier earnings and revenue comparisons. Growth worries in the PC, wireless phone and telecommunications gear markets will be over, at least to the extent that we'll know how much of a slowdown these sectors will see and can start anticipating the next up-tick in demand.

So, yes, I think 2001 will be an OK year, and after the punishment that many of us have absorbed in 2000, OK will seem just fine.

Unless, of course, we slip into a recession next year. In which case, all bets are off.

Arrogance + Inexperience = Mistakes

Why would we have a recession in 2001? It's not because the economy seems to be slipping into reverse -- economic growth is pretty clearly slowing, but I think we're still looking at better than 3% growth in 2001. And it's not because I think the inflation-fighting hawks have seized control of the Federal Reserve and will hike interest rates next year; I think the Fed, which seems to have started to let the money supply grow again, is genuinely on the fence and is likely to remain there.

Nor do I see a war in the Middle East driving up energy prices or a world financial crisis. I'll leave that kind of guessing to the folks with better crystal balls than mine.

Nope, there's only one reason to bring up the "R" word, and that's because 2001 will be the first year of either a George W. Bush or an Al Gore presidency. And history shows that the first year of a presidential term increases the odds of the economy dipping into recession. (Just to keep our definitions straight, an economic recession is defined by most economists as two consecutive quarters of decline in the U.S. gross domestic product. President Bush presided over the last one in 1990, and it quite possibly cost him the election when he ran against Bill Clinton.)

How often does the "presidential curse" strike the economy? It's not a sure thing by any means, but the effect is pronounced enough to get my attention. According to data from InvesTech Research, nine out of the last 20 recessions began in the year flowing a presidential election. Just looking at recent history, the recessions of 1953, 1957, 1961, 1969, 1973 and 1981 all set in after a presidential election.

I don't think there's a single, overriding reason behind this pattern -- but I think there is a general theme that links recessions and new administrations. I'd chalk it up to the heady brew of arrogance with which a new administration often takes office, mixed with what is often appalling inexperience.

It's pretty easy to understand why new administrations would be arrogant. The new team has just won an election and is eager to flex its muscles. The voters put them in office to do something, didn't they? So something is exactly what the new folks are going to do. That's especially true when the election has resulted in a change in party control of the White House, which means that the new team starts with "a mandate for change." The recessions of 1953, 1961, 1969 and 1981 all correspond with such a change.

Most administrations come into office knowing that their best chance of getting anything done is at the beginning of the term -- the days before the last bit of bunting is retired on Pennsylvania Avenue. Most administrations begin with more clout in Congress than they'll ever have again in their four-year lives.

No matter which party wins the current election, I guarantee that come January, the national media will be running stories about the need for the new team to "hit the ground running" and lamenting that the administration-in-waiting still doesn't have a complete economic plan and team in place. "What are they waiting for?" Sam Donaldson and others will ask from outside some Washington power hotel. "It's just two weeks until the inauguration!"

The pressure to get something done increases with the size of the incoming administration's platform for change. Recent administrations have been savvy and cynical enough to push for wrenching change early so that voters have a chance to forgive and forget any early-term disasters. The Reagan administration's supply-side revolution and the Clinton administration's health care overhaul were both big ideas pushed in the early stages of a new administration.

Here's what we have so far: huge new ideas pushed hurriedly into place by an executive team puffed up with the correctness of its own approach. Sounds like a recipe for making mistakes. But we're not done yet. Any new administration also comes to Washington with major gaps in its experience. Oh, the resumes may list all the right schools and accomplishments, but the team will inevitably be light in terms of experience in dealing with some of the major players that determine the course of this nation's economy.

Will the new team know what to say to keep Wall Street calm, for example? Will it have the confidence of Alan Greenspan and the rest of the Federal Reserve? Will it be able to quash the worst ideas coming out of the lunatic fringe of its own party without alienating those votes forever?

These aren't abstract issues of policy, but concrete questions of personality. A new Treasury secretary -- and undersecretaries -- will have to sit down across the table from Greenspan. The White House press secretary will have to learn how not to rattle bond traders when he or she takes questions on tax cuts and spending plans. Any two strangers have an increased chance of misunderstanding each other, and it's no different here. It's only that the consequences are somewhat larger.

Areas to Watch

None of this assures that any incoming administration will make mistakes. It only suggests that the odds are higher that a new team will blunder on an important matter. And I think it's possible to figure out in advance -- from the two candidates' campaign proposals -- which areas to watch for signs of initial mistakes getting out of hand in a way that might damage the economy. I'd focus on two areas: tax cuts and the federal budget.

Both Bush and Gore need to make sure that the tax cuts they've proposed don't provoke a retaliatory strike from the Federal Reserve. Whatever different schools of economists believe, the central bankers think that tax cuts are inflationary. Make the cuts too big and the Federal Reserve will be tempted to wave the rhetorical sword of another interest rate hike, and if that has no effect, to actually raise rates in response. It won't, however, take anything more than talk to make the markets nervous.

I think the danger here is more extreme in a Bush administration than a Gore administration, simply because the proposed Bush cuts are bigger and because the Gore team has some experience in talking with Greenspan and the rest of Federal Reserve.

Both presidential camps have shown a propensity to spend $2 out of every $1 in the projected federal budget surplus, while Congress -- if the pork oinking out of Washington in October is any indication -- has seemingly decided that enough budget restraint is enough.

Any new administration -- especially if it coincides with a clear majority for either party in Congress -- could result in spending proposals that go directly against Alan Greenspan's advice to save the surplus. As with tax cuts, too much spending, and maybe even too much talk of spending, could lead the Federal Reserve to say enough to rattle Wall Street.

I can think of other potential economic missteps. Bush's plan to privatize part of Social Security is likely to make the Federal Reserve worry again about the return of "irrational exuberance" just when a retreating stock market has taken the inflationary force out of the wealth effect. Too much anti-business rhetoric from Gore as part of a plan to control drug costs could depress the stock market enough to lead to further cutbacks in capital-spending plans. And so on.

If I could give just one bit of advice to any incoming administration it would be this: Please remember that the World War II slogan designed to fight Axis spies -- "Loose lips sink ships" -- also applies to presidential administrations and the economy. With growth slowing, rhetoric counts. Nobody wants to go down in history as the guy who ended the longest economic expansion in U.S. history, do they?