Democrats, Republicans and the abyss

The polarized, poisoned political climate has caused the current crisis. Democrats have employed various cunning methods to push Obama’s showpiece – the Affordable Care Act – through Congress (without the support of a single Republican lawmaker) and now the GOP refuses to accept that Obamacare is “the law of the land”, which has been legitimized by the Supreme Court as well as by dozens of failed attempts in Congress to dismantle the Act. Democrats have chosen to disregard the unwritten rule that revolutionary legislation should be passed with bipartisan support. Many Republicans see Obama as the “devil incarnate/”

The moderate Republican leadership does not have a lot of room for maneuver – many want to be reelected next year and fear that they will be ousted by a Tea Party candidate unless they stand fast. Democrats will not give up Obamacare because it is Obama’s signature domestic achievement. To all appearances, there has been no rapprochement between the parties in the past days.

{mosads}The key question is: Do the politicians fear the markets sufficiently to strike a deal? Increasingly, it seems that a compromise will have to be a “package deal” comprising the shutdown, the debt ceiling, a number of adjustments to Obamacare and some agreements about a second round of sequester spending cuts.

If the two parties manage to see eye to eye at all, this does not provide reassurance for the long term. A continuing resolution (CR) will probably run out halfway through December. The raised debt limit, if it comes about, will only be valid for no longer than little over a year and possibly only a few weeks.

So what is in store for the U.S.? The first, optimistic scenario is that in the coming days enough House Republicans (approximately 20) get behind the Democrats and Republican Speaker John Boehner tables a vote on a so-called clean CR (a stopgap spending bill that is not contingent on the defunding of Obamacare). Subsequently, both parties will vote to raise the debt limit – because market panic threatens – without doing serious damage to Obamacare. Unfortunately, the chance is slim that such a positive scenario will unfold. Both Democrats and Republicans have beaten the big drum so loudly that they will find it very hard to water down the wine unless the water is up to their necks.

Then what about the second scenario; the nuclear one? Are politicians really capable of pushing the economy into the abyss out of ignorance, rage, misconceptions, and a lack of understanding what this is all about? If so, the markets will nosedive. The only certainty is that the USA will be in a right mess. Although we can’t disregard such a “fat tail risk,” it would seem that even the most combative politicians will think twice before condemning America to become the laughing stock of the world. The joke could backfire if it pushes the global economy into a recession.

We cannot rule out this ominous scenario. Based on the previous shutdown (in 1995/1996) part of the GOP is convinced it should never blink first. Meanwhile, Democrats believe they won that skirmish because the GOP gave in too easily. Should both parties subscribe to this interpretation of history, they may continue to gallop towards each other, determined not to swerve out of the way. If so, a head-on collision becomes inevitable. The likes of Ted Cruz make no secret of their dislike of Wall Street and they know that a refusal to compromise will fill their supporters with glee. So in a worst-case scenario they could, initially, choose to ignore the mushroom clouds forming above the US stock exchange.

The third, most likely scenario (considering the dangerous political climate and the merciless power of the markets) is that the politicians will not conclude a deal for another while but wait until the very last moment. Under such conditions, i.e. in the run up to a compromise, the markets could lose 10 or 20 percent and the dollar could tumble. Subsequently, politicians can hide behind the markets and make a deal because they will be able to tell their voters that, sorry, they did remain principled for as long as they could but nobody can refuse to move once a deep recession looms.

Most likely, Democratic and Republican lawmakers will pull the U.S. away from the edge of the abyss, but this dangerous political drama will harm the domestic and global reputation of U.S. politics even more after, among other things, the NSA/Snowden/Prism affair, Congress’ historically low approval ratings and the flip-flopping on Syria.

Langenkamp is political analyst at ECR Research and ICC.