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Commentary: Headwinds for the Bush Administration

By Anthony Ogorek

Buffalo, NY – With the presidential inauguration now history, there may be a tendency to assume that we will be seeing four more years of the same policies from the administration. It is worth noting that the Bush Administration, after being narrowly returned to office over continued concerns about its foreign policy, has made its domestic agenda the centerpiece of a second term.

The irony of this situation is that although President Bush hopes to pin a large part of his legacy on modernizing Social Security as well as the federal tax code, his domestic agenda will be held hostage by the fiscal constraints imposed by the war in Iraq. These fiscal constraints will not only impact Bush's ability to implement his second term agenda, but have also created headwinds for the financial markets; but more on that later.

Whatever your political persuasion, one thing we can all agree on is that fixing Social Security, which is on an unsustainable track, will be an expensive proposition. If the president is successful in advancing his agenda, there will be very significant outlays in the form of perhaps trillions of dollars of federal debt issued to bridge the gap between the current and future versions of Social Security. This will not be an easy sell with the federal budget as out of balance as it is today. A more painless stopgap measure would be indexing cost of living increases from a wage based measure to a CPI based one.

Replacing the federal tax code would be a momentous and long overdue accomplishment. Much of the accounting and legal professions have grown up around the code. With the tax compliance burden reduced or eliminated through some type of flat tax, the economy could expand at a more rapid rate, thereby helping us to grow out of not only deficit spending, but into a new reality for the Social Security program. As we mentioned earlier, there are forces afoot that will make any structural changes difficult.

Tailwinds that helped President Bush advance his first term agenda have turned into headwinds that may threaten his second term initiatives. In an attempt to diffuse the potentially disinflationary effects of above trend productivity growth, the Fed has reduced interest rates dramatically. Although this policy initiative had a salutary effect on the prices of stocks, bonds and real estate, the Fed is now in the process of reversing its accommodative stance. Last year it raised short term rates five times. It is our expectation that the Fed may raise rates an additional five times before it is through with its tightening cycle.

Another headwind is fiscal policy. During the president's first term he embarked on very significant deficit spending which was aided by two reductions in tax rates. In spite of very significant outlays for the war in Iraq, as well as an expensive prescription drug program for seniors, it is difficult to see how the deficit will be halved as the president proposes. In a second term we can expect the federal government to pull in its belt. That means less stimulus for the economy.

The reason the Fed was able to keep rates so low for so long without inflation returning is productivity. During the past ten years, productivity, or the output per worker was well above trend, supposedly due to the integration of computers, networking and the Internet into the workplace. Unfortunately, productivity has been declining as of late. This will not only increase costs for corporate America, but may cause the Fed to raise rates more aggressively than when productivity was higher.

What all this points to is a more difficult environment in which to raise corporate profits, to make money, and to govern.

Commentator Anthony Ogorek is principal of Ogorek Wealth Management in Williamsville.