The Tea Party is certainly shaking up the political world. They have taken control of lots of races around the country.
But what impact will they have on the economic world?
We don’t know how many Tea Partiers will be elected. Also, how many Tea Partiers will turn into normal politicians after elected? I don’t know.
But I think it is certain that they will have an impact, the only question is how much impact. So I think we can start to figure out what the impact will be though it may be too early to figure out how strong the impact will be.
One of the key concepts of the Tea Party is fiscal responsibility. What this really means is that they want to cut spending and taxes.
Right now, the fiscal policy of the US is to be massively loose. We are seeing the largest deficits in human history. This is combined with the loosest monetary policy since the 1860’s.
The Tea Partiers will work to cut the spending. They will try to block any increases at all. They will work to cut taxes and spending.
However, there is little that is discretionary. Less than 20% of the spending of the Federal government is discretionary. The vast majority is statutory. That is, it is required under law. For example, Medicare is a statutory expenditure that mandates a certain amount of spending each year no matter what Congress and the President want. The only way to cut that spending is to pass a new law.
Well, there is another way to cut spending and that is to try to work harder to cut waste and fraud. I would imagine that the Tea Partiers will try to get the Administration to do a better job but the Tea Partiers don’t control the Administration so they can only hold hearings assuming they get enough seats and seniority to be able to hold hearings.
So the critical aspect is whether or not the Tea Partiers will get enough strength to actually pass new laws to cut the statutory spending.
The short answer is no. But that the threat of yes will roil the stock market.
During elections, most candidates talk a fiscal conservatism. Even Obama tried to set himself up as a tax cutter! So the talk leading up to the election will be very focused on fiscal responsibility. The right will talk about cutting spending and taxes while the left will talk about raising taxed to cut the deficit. Both will be talking about cutting the deficit but they will disagree about the way to do it. Still just about all candidates from both parties will shift to the right on fiscal policy before the election.
This will lead to ideas of fiscal austerity by the market. They will think that there will be a period of at least two years (until the 2012 elections) that there will be little or no spending growth from the US government. I doubt that the market will look for actual spending cuts. That would be unheard of in Washington!
So what does it mean for the stock market?
I think the initial impact is negative as the market believes that a cut in spending or a cut in the growth of spending will cut economic growth. The longer term impact is bullish as the market will finally come to see that cutting government spending will reduce the amount of the economy that goes into the government. A reduced economic commitment to the government usually means less regulation and government taxes and uncertainty which are all bullish for the stock market.
It is probably a mixed bag for gold. The economy will grow slower and there will be less inflation which are both bearish for gold. But there will be spikes of safe haven buying when their are the inevitable conflicts over the spending cuts.
One thing is certain. The ascendency of the Tea Party is throwing a big uncertainty into the mix. We pretty much know what mainstream Republicans and Democrats do when they get into power. We don’t yet know what the Tea Partiers will do.