Stephen King: It's the economy again, stupid ... here we go again

"It's the economy, stupid!" This was the phrase which probably won Bill Clinton the Presidency in 1992. In the early stages of that particular race, it seemed as though George Bush Sr was unbeatable as he rode the crest of a foreign policy wave following the apparently successful conclusion to the first Gulf War.

Clinton's team, however, was quick to recognise that Mr Bush's foreign policy success was not matched by domestic economic accomplishments. The economy, after all, had gone into recession in 1991. Even though there were signs of improvement in 1992, unemployment continued to rise. In this so-called jobless recovery, Mr Bush's reputation became increasingly tarnished and the Comeback Kid eventually ended up walking into the White House.

In 2008, it's the economy again, stupid. Although George W Bush is not up for re-election and, therefore, unlike his father, can't be booted out by the voters there's no doubt that the important issues surrounding this year's Presidential election are beginning to shift. Until recently, opinion polls suggested American voters were mostly concerned about the war in Iraq (most people polled strongly disapproved of the Bush administration's policies there). The voters' focus, though, is changing. Although Iraq still dominates, latest opinion polls suggest the economy and jobs are becoming much bigger themes.

Voters, unlike some political campaigners, aren't always stupid. They know about the weakness of the US housing market. They know the economy is not as strong as it used to be. Some of them are beginning to focus on job insecurity. And more and more are thinking that the US economy is already in recession.

The voters are right to be concerned. The big surprise in 2007 was the ability of the American economy seemingly to tread water. Although the housing market was, in some regions, disturbingly weak, the economy in aggregate expanded at a reasonable pace. Most estimates suggest that, for the year as a whole, national income rose by a little over 2 per cent, helped along by robust exports. Admittedly, this pace of growth is well below the gains seen in the heady days of the late-1990s (as Senator Hillary Clinton will be reminding anyone who cares to listen in the weeks ahead) but, in the light of the housing meltdown, it's not a disaster.

At least not until now. Last week, two pieces of economic news suggested that the economy as a whole might finally be succumbing to the pressures associated, firstly, with the housing market and, secondly, with the banking sector meltdown in the second half of 2007.

The first important data release was the closely watched manufacturing barometer from the Institute of Supply Management (ISM). In December, the overall index fell below the 50 "boom-bust" line for manufacturing (for the economy as a whole, the critical boom-bust level is supposed to be around 45). More importantly, though, the new orders series drop-ped 6.9 points to 45.7. As Ian Morris, HSBC's US economist, points out, a decline on this scale in such a short space of time is a significant cause for concern. At the very least, the Federal Res-erve will be cutting interest rates a lot further in the months to come.

The second major piece of news came in Friday's US employment report. This release gets a remarkable amount of attention within financial markets given the scale of later revisions and the associated re-writing of history. Even for sceptics, though, the latest numbers, for December, point to worrying developments in the US labour market.

Specifically, although the unemployment rate rem-ains low, it jumped 0.3 percentage points in the month, rising from 4.7 per cent to 5.0 per cent. Increases of this scale are very rare indeed. The last two months when unemployment rose by this amount were August and October 2001, when the US economy was in the depths of the last recession.

These, then, are worrying developments. They don't guarantee a headlong descent into recession, but they certainly suggest that that the risks of recession are now uncomfortably high. Moreover, the sudden lurch downwards in the data will make the Presidential election increasingly a plebiscite about perceived competence on economic policy.

At this stage, the race is too wide open and the assorted candidates' policies too vague to be able to provide an unambiguous picture of US economic developments post-Bush. The issues, though, are clear.

What should be done about the US housing market? Should a new administration work hard to reduce the number of housing foreclosures (which, given the elevated level of house prices in the US even now, will be an ongoing problem in 2009)? What about rising levels of inequality and the absence of real income gains for middle class voters (one of Mike Huckabee's themes)? And how about America's relations with its foreign rivals? Will Hillary be as supportive of free trade and globalisation as Bill once was (unlikely given Mrs Clinton's apparent distaste for the North American Free Trade Agreement in its current form)? And what about America's relations with China (Barack Obama is keen to hold the Chinese to account on their supposed currency manipulation)?

The big worry is, of course, that the candidates too easily press the populist vote-winning button. At a time of economic distress and rising unemployment, it's all too easy for politicians to blame somebody other than "their fellow Americans". And there are, of course, plenty of scapegoats, including the Chinese, the oil producers (whether in the Middle East, Venezuela or Russia), emerging market sovereign wealth funds (intent on buying up American assets), foreign banks and unfair competition from non-unionised cheap labour elsewhere in the world.

The truth, unfortunately, is less palatable. The US has borrowed heavily from ab-road for many years, reflected in an ever-wider current account deficit. For a while, in the mid- to late-1990s, this additional borrowing made sense, because the US was able to demonstrate superior productivity gains relative to its main rivals. After the 2000/01 stock market crash, however, the economy slowed and, as it did so, productivity performance faded. While, in the late-1990s, America borrowed from the rest of the world to invest in cutting-edge technologies, more recently, money borrowed from abroad has been mostly invested in a now-collapsing housing market.

This isn't the fault only of the US borrowers. The global creditors should have thought twice before pouring their savings into the US housing market. Never-theless, it seems increasingly likely that the US will no longer enjoy the easy access to global capital markets that proved to be one of the major foundations of the success of Clinton I through the 1990s. That's likely to mean a structurally less wholesome economic performance.

In many ways, then, the forthcoming Presidential election is one to avoid winning. Doubtless, all the candidates have high ambitions for the US economy and America's role in the wider world. Whoever wins, though, will in all likelihood discover that their victory is, initially, something of a poisoned chalice. Rising unemployment, a falling dollar, a weak fiscal position, a possibility of recession and an ongoing housing crisis will provide major challenges.

Still, reputations are made in challenging times. Both Ronald Reagan and Bill Clinton entered the White House in times of economic disarray and both eventually emerged with their reputations much enhanced.

Stephen King is managing director of economics at HSBC mailto:stephen.king@hsbcib.com