By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

No question, President George Bush’s approval ratings have pulled an “Enron.”

A recent Associated Press-Ipsos poll conducted June 12-16 showed only 29% of the public gave Bush a favorable rating. It’s the least favorable approval rating for a U.S. president since Jimmy Carter’s approval rating dropped to just 22%.

While that lousy view of the job Bush is doing will help set up a more-contentious election in November, here’s a curious fact that investors will find quite rewarding:  The key to better stock-market returns isn’t having a president we “love” – it’s having a president that we don’t quite hate.

Let me explain.

According to a study of presidential approval ratings by Ned Davis Research that looks back all the way to the days of President John F. Kennedy, when the president’s approval rating is below 35%, as it is now, the Dow Jones Industrial Average Index loses an average of 5.9% per year. When times are good and presidential approval ratings exceed 65%, the Dow rises at an annualized rate of 2.6%. But when just 50%-65% of the public gives a favorable rating, the markets do a bit better and the Dow rises at a 5.4% annualized clip. [Click here for the full chart on how the Dow has performed during different presidential administrations.]

Now here’s the really interesting part.

When the majority of Americans disapprove of how the president’s doing his job, and the approval rating clocks in between 35%-50%, the Dow posts an average annualized gain of 12.3%. In other words, when less than half the population has a favorable view of a sitting president’s performance, the Dow’s upside potential improves by 127.78%.

Talk about a counter-intuitive result!

For next year, then, it seems that the key isn’t for us to elect a president that everybody likes; instead, the country needs to elect a president that the masses “hate” a bit less than they dislike Bush and who only does his job well enough to garner the support of between 35% and 50% of the population.

Anything worse, and the Dow could fall, which given “The Dubya’s” current lackluster rating, is right on track for how the markets are behaving lately.

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And that has us thinking: Who amongst the presidential contenders that are left do we like the least?

[Editor's Note: This story is part of Money Morning's ongoing "Election 2008" series covering the investing impacts of the presidential campaign. Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and John Edwards and concluded that Obama and McCain would be the best candidates for investors. For a full report on the "presidential profit plays" that was derived from Hutchinson's research, please click here. The report is free of charge.]

News and Related Story Links:

• Money Morning:
  Election 2008: Obama or McCain – U.S. May Suffer Either Way

• Money Morning:
  Election 2008: The Achilles’ Heel of Obamanomics

• Wikipedia:
  United States Presidential Approval Rating

• Website:
  Ned Davis Research

Presidential hopeful, Barack Obama, recently told The Wall Street Journal that he intended to lift the United States out of recession through a burst of government spending on infrastructure and a venture capital fund for the new energy sector.

Obama has made few economic mistakes in his campaign – he avoided the economically counterproductive proposal to cut petrol taxes between Memorial Day and Labor Day backed by both John McCain and Hillary Clinton – but he has shown his Achilles’ heel with this proposal. There may be many reasons to increase government spending, to better defend America or to introduce a more generous healthcare plan or other social programs, but helping the economy recover is not one of them.

In the long run, higher government spending makes the economy worse.

This may seem heretical to those brought up on the doctrines of John Maynard Keynes. Or maybe it’s just simply reactionary – a position to be expected from a Reaganite mossback who fails to recognize that the world has changed. 

But the Keynesian doctrine that public spending can boost an economy out of recession fails to distinguish between two effects of a public spending surge: a larger budget deficit and a transfer of resources from the private to the public sector.

A larger budget deficit does indeed boost the economy in the short term, as expenditure increases, regardless of whether that deficit is attained through tax cuts (such as this year’s “stimulus”) or higher spending. However, it also increases public debt, thus incurring greater costs for future years, and in times of tight liquidity (which we have not seen since the early 1990s) it can force up interest rates, “crowding out” financing in the private sector.

Obama has not recommended a larger budget deficit; indeed it is difficult to believe that he could. The annual deficit is already approaching $500 billion, and the revenue effects of the 2008 slowdown have not yet been felt, since corporate taxes and individual taxes on large bonuses are both paid in arrears – it will thus be early in 2009, about the time of Obama’s inauguration, if he makes it, that the true effect of the slowdown is seen in a deficit that will almost certainly yawn beyond $500 billion. Obama may save money by withdrawal from Iraq (though that withdrawal might well take a considerable time) but he also plans to spend money though his health plan; there will thus be no money to spare.

The problem arises with higher public spending, the transfer of resources from the private sector to the public sector, however it is financed.

By definition, private sector spending is economically optimal; it reflects the owner of the resources’ view as to the best use of those resources. Public spending, on the other hand, cannot be economically optimal except by accident, because it represents bureaucrats, however well meaning, making choices on behalf of others, which are unlikely to coincide with the preferences of the beneficiaries.

On the investment side, public sector investment frequently results in losses, because of the lack of market signals showing the investor where to put its (or rather the taxpayer’s) money. Finally, in a political system like the United States, where lobbying is powerful, resources that flow through the public sector are themselves subjected to a tax of unnecessary boondoggles and pork-barrel spending, further inflating public-sector costs compared to the private sector.

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This is not just theory. Statistical studies using Organization for Economic Cooperation and Development (OECD) public spending and growth rate data have shown that both the level of public spending (in terms of gross domestic product (GDP)) and its rate of increase are inversely correlated with economic growth, with the combination of the two factors explaining slightly over half the differences in growth rates between different countries and different time periods.

This is intuitively sensible; a large public sector starves the productive private sector of resources, stifling productivity growth, while a rapidly growing public sector sucks up all the new resources generated by economic growth, further starving private enterprise.

There are numerous examples of public sector growth stifling economic growth. Back before modern statistics, the sharp rise in public spending under thirty-first President Herbert Hoover (which was extraordinarily matched with a huge tax increase in 1932) was a major contributor to the depth of the Great Depression.

Meanwhile Britain kept public spending under control, cutting public sector wages by 10% in 1931 when times for all were hard, and had both a shallower Great Depression and a much shorter one; output was above its 1929 level by 1934 and grew rapidly from then on, well before serious rearmament began.

Well into the era of modern statistics, France and West Germany both enjoyed “economic miracles” in the 1950s and 1960s, then growth dropped sharply – in the early 1970s for Germany and the late 1970s for France.

When you examine the statistics you find out why.

The leftist Social Democrat Chancellor Willy Brandt increased German public spending by 10% of GDP in 1970-75. West Germany then enjoyed slow growth in the 1980s before it entered stagnation through a further increase in public spending by 7% of GDP in 1990-96 (related to the reunification with East Germany).

In France, the conservative Georges Pompidou died in April 1974, and his successor Valery Giscard d’Estaing, followed in 1981 by the leftist Francois Mitterrand, ratcheted up public spending by no less than 14% of GDP between 1973 and 1984.

Then there’s Japan. The “Lost Decade” of the 1990s would have been grim anyway, because of the collapse of the 1980s stock market bubble, but the Japanese government certainly didn’t help by pushing public spending up by 8% of GDP between 1990 and 2002. Only after Junichiro Koizumi reined back public spending in 2003 did growth resume. Like Obama, Japanese leaders believed that infrastructure spending would boost the economy; they raised it to 6.5% of GDP, then the highest in the world – and saw the policy miserably fail.

There’s a lot to like about Barack Obama, and a fair amount for investors to like about his policies. But a look at global history shows his belief that public spending in and of itself would boost the economy is contrary to reality.

[Editor's Note: Money Morning Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and John Edwards for our ongoing "Election 2008" series, and concluded that Obama and McCain would be the best candidates for investors. For a full report on the "presidential profit plays" that was derived from Hutchinson's research, please click here. The report is free of charge.]

News and Related Story Links:

• Money Morning:
  Election 2008: Obama or McCain – U.S. May Suffer Either Way

• The Wall Street Journal:
  Obama Plans Spending Boost, Possible Cut in Business Tax

• Wikipedia:
  Achilles’ heel

By Martin Hutchinson
Contributing Editor

As Barack Obama closes in on the Democratic presidential nomination, investors should focus their minds around one uncomfortable fact: Whether it’s Obama or Republican John McCain who wins the White House, expect some policy changes that won’t sit well with investors – or with the U.S. economy.

This could make for several rough years for U.S. investments, underscoring yet again the importance of searching out profit plays overseas.

That’s why it’s crucial that we understand just what each candidate is likely to do should he reach office. Interestingly, there are three areas where the two presidential hopefuls seem to be in agreement. Indeed, no matter which candidate reaches the White House, investors can expect there to be:

• An introduction of a “cap-and-trade” carbon-emissions-control system.
• Higher taxes.
• And stepped-up regulation of the U.S. financial-services sector.

Warming Worries Will Spawn Emissions Regs

Of all the anticipated changes, the most widely publicized is the expected introduction of a so-called “cap-and-trade” carbon-emissions-control system. Both Obama and McCain favor such a system and Congress is currently drafting legislation that is not expected to pass this year (while George W. Bush is still president), but to form a template for legislation from a Democrat-controlled Congress to be signed by either Obama or McCain in 2009.

The most economically efficient way to curb carbon emissions is by means of a carbon tax. Such a tax would penalize emissions by polluters at a flat rate per ton, and could be offset by reductions in other taxes – a decrease in the corporate tax rate, for example – thus neutralizing its overall economic effect.

Provided the tax was set at a moderate rate, it would provide incentives to shift from carbon-based fuels to other energy generation systems, while the market itself would determine which carbon uses would be discontinued and which were too expensive to change. It wouldn’t matter too much at what level the tax was initially set, since a moderate error in setting the level would produce only moderately suboptimal polluter behavior, as the incentives produced either a little too much clean-up and consequent economic damage, or not quite enough.

The carbon tax is unpopular with politicians, because of the word “tax.” From bitter experience, they have found that raising taxes leads to unpopularity and, ultimately, to electoral defeat. Even if other taxes are lowered, the squawks of the complaints and protest of the losers are always much louder than the contented purring of the winners. That explains their preference for a “cap-and-trade” emissions policy, under which politicians pretend to give something away, providing licenses to pollute, which can then be traded among users.

The main difference between the cap-and-trade schemes of McCain and Obama is this: McCain would allow the government to give out permits to polluters while Obama would auction off permits.

At first glance, McCain’s approach appears more pro-business, but consider this: If the government gives out the permits, it gets to choose which companies get what permits. That creates a huge new playing field for lobbyists and opens the door to all sorts of new opportunities for corruption, as polluters “compete” to gain the political favor of an emission permit allowance. Already in the draft Congressional legislation provision is being made for favored groups to be given special allowances of emission permits – essentially the same as the government giving them cash, as the permits will have value.

Under Obama’s proposal, however, the government will auction off the permits. That will ensure that their price is set by a market process, and that companies neither gain nor lose by their special access to legislators. It’s a much more honest process, and a much-better representation of the “free market.” And the extra revenue it generates can be returned to the taxpayers via tax reductions in other areas.

Indeed, the only disadvantage of Obama’s proposal compared to a carbon tax is that the government has to determine initially how much carbon should be emitted. That is a very difficult parameter to determine, and an error of 1%-2% in either direction can have a huge effect – as shown by the 2004-07 European Union emission permits, where too many were given out. As a result, the prices in the permit trading market dropped 98% in a couple of weeks, as companies discovered there were ample permits for all. A market with that degree of uncertainty is far more likely to result in corporate-finance game playing than in any serious reduction in emissions.
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McCain’s proposal contains a number of additional potentially detrimental features. Under it, reducing emissions in emerging markets can satisfy emissions requirements. But as the European Union has discovered, one spin-off effect has been the creation of a thriving market in Chinese environmental-cleanup scams. Further complicating the scene is the fact that some industries would be partially exempted in order to allow for transitional difficulties – providing another fertile field for government meddling and corruption. Still, even with Obama’s proposal, a “cap-and-trade” system is likely to do significant economic damage, and given the fact that legislation would need to be drafted by Congress, the chance of huge economic distortions must be considerable.

The Taxman’s Bigger Bite

A second area where both candidates essentially agree is that taxes will be higher. McCain obfuscates this, because he needs to preserve his relations with the Republican “base.” But he has made it very clear that fiscal discipline in terms of balancing the U.S. federal budget is his most important economic objective. And he favors further activity in the Middle East, a fact that’s likely to involve an expansion of defense spending. Since, even without a recession, the federal deficit in the years to September 2008 and 2009 will be close to $500 billion, McCain’s balance-budget objectives cannot be achieved without tax increases, both reversal of most of the 2001 and 2003 tax cuts and increases beyond that.

Obama has been more up-front about his desire to reverse the 2001 and 2003 tax cuts, and to impose Social Security contributions on incomes above $200,000. Since he also favored U.S. Rep. Charles B. Rangel’s bill, which increases income taxes on higher incomes, an Obama administration could potentially increase the top marginal rate of income taxes increase from 35% to 52%.

Obama also favors an increase in the capital gains tax rate from its current 15% to at least 20%. On the positive side of the budget, an Obama administration would presumably save money in the Middle East. And his health-care plan, which mandates coverage for children but not for adults, would presumably be somewhat cheaper than Hillary Clinton’s plan.

Nevertheless, tax increases are inevitable no matter who wins in November. And if Obama were to win those new levies might include a supercharged capital-gains tax and even dividend-tax increases – either of which could hammer U.S. stock prices.

Financial Services Scrutiny

A third area of agreement between the candidates is in greater regulation of the financial-services business. From the viewpoint of a retail investor, this may be a good thing: After all, who could object to fewer scams and rip-offs, or-less-egregiously overpaid investment bankers?

However, the ideological impetus behind such regulation differs significantly. Obama believes in regulation in general, but he has no great objection to investment bankers themselves (many of whom are his ardent supporters).  But McCain, by contrast, despite being from the party of low regulation, has no great objection to regulation in general and displays a visceral dislike of investment bankers.

Both candidates would probably press the U.S. Federal Reserve to impose tighter leverage restrictions to deter further blowups of The Bear Stearns Cos. Inc. (BSC) type operations – even though such central bank initiatives ultimately would harm taxpayers. And Obama has seemed sympathetic to the argument that the 1999 repeal of the Glass-Steagall Act separating commercial and investment banking was a bad idea.

Either way, investments in U.S. securities may be somewhat safer for the retail investor, particularly the retail investor in mortgaged-backed securities, asset-backed commercial paper and other exotica, but the stocks of financial-services companies themselves are likely to be long-term dogs.

Finally, whichever candidate wins, interest rates are likely to rise. Neither candidate wants them to, but the policies of the past decade – keeping rates as low as possible and hoping that inflation doesn’t reappear – seems close to bankruptcy. At some point, the Fed will have to raise rates, and that will have a knockout effect on both stock prices and on the U.S. economy.

If there’s one prediction I can make from this analysis, it’s this: It looks very much to me like there will be a rough few years ahead in the United States, whichever candidate wins.

How fortunate that we can escape almost all of these difficulties by investing in emerging markets.
[Editor's Note: Money Morning Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and John Edwards for our ongoing "Election 2008" series, and concluded that Obama and McCain would be the best candidates for investors. Hutchinson wrote about the "Potomac Primaries" in mid-February. For a full report on the "presidential profit plays" that was derived from Hutchinson's research, please click here. The report is free of charge].

News and Related Story Notes:

• CNN.com:
  Clinton plans exit as Obama gathers more support.

• CNN.com:
  Warner-backed bill to curb carbon emissions gathers support.

• Money Morning News Analysis:
  Dallas Fed President Lends Credibility to Money Morning’s Prediction That the Federal Reserve Will Soon be Boosting Interest Rates.

• Money Morning Financial Commentary:
  With Oil Speculators Blitzing, the Fed Needs to Call an Interest-Rate Reverse Play.

• Wikipedia:
  Carbon Tax.

• The Catalyst:
  How it Works: Cap-and-Trade System..

• Wikipedia:
  Emissions Trading.

• SCSU Scholars:
  Gore Should Run in Europe (European Emissions Problems).

• Wikipedia:
  Glass-Steagall Act.

By Martin Hutchinson
Contributing Editor

With contests in both Indiana and North Carolina, today (Tuesday) probably marks the last of the crucial Democratic presidential primary election contests between senators Hillary Rodham Clinton and Barack Obama.

Unless the cynical premise of Rush Limbaugh’s "Operation Chaos" is realized, and the Democrat presidential wingding continues to move forward at an increasingly vitriolic level through that party’s national convention in Denver in late August, whomever wins the Democratic nomination is pretty likely to be our next President. So, as investors – whether Democrat or Republican – which of the two candidates should we be rooting for?

The Case for Clinton

Our initial reaction would probably be that this question looks like a no-brainer. The Standard & Poor’s 500 Index rose from 427 to 1,342 during the eight-year administration of Hillary Clinton’s husband, giving investors an average annual total return of 17.4% – the highest of any presidency since World War II.

That huge market run-up – and the hefty yearly returns – were pretty much justified. President Bill Clinton was committed to a balanced federal budget, raised taxes only once, and that in a moderate fashion, reformed welfare and signed the North American Free Trade Agreement (NAFTA).

All of those policies were immensely beneficial to the U.S. economy – and to investors – as, in the short term, were the monetary expansion policies of the Alan Greenspan-led U.S. Federal Reserve (although we may well be paying the long-term price for that now). If we could be sure that Clinton would follow her husband’s policies, and that the economy was in a state fairly similar to that of 1993, we could as investors be confident that a Hillary Clinton presidency would contribute significantly to our collective net worth and, on balance, would serve the entire country equally as well.

Unfortunately, there are two problems with such optimism. First, Hillary Clinton’s policies differ significantly from her husband’s. Second, the U.S. economy today is in a very different position than it was in 1993, so different policies and capabilities are required.

There are two obvious policy areas where Hillary Clinton differs from her husband: trade and taxes. Sen. Clinton now claims she would have opposed NAFTA; certainly, she pretty much opposes any other trade agreement that’s up for discussion. For investors, international free trade is extremely good for business and, hence, for profits. The costs of very free trade are largely borne by the less-skilled workers of rich countries; its benefits flow largely to corporations. That’s why free trade is a tough political sell, even though its overall benefits greatly exceed its costs. As investors, however, we should be wildly in favor of it.

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When it comes to taxation, Sen. Clinton wants to reverse the George Bush tax cuts, and favors increases in the Social Security tax for those at the top of the income scale. She also favors a higher capital gains tax – all measures that tend to reduce both economic growth and investor returns. She also favors windfall taxes on oil companies, and has a healthcare plan that would be very expensive and that must be paid for somehow.

Perhaps the biggest difference between the two Clinton’s is Hillary Clinton’s economic populism. When Bill Clinton ran for president in 1992, he campaigned on the catchy platform, "It’s the economy, stupid." But he was notably free of the economic redistributionist and corporation bashing that had weakened the credibility of such presidential campaigns as Walter Mondale’s in 1984 and Mike Dukakis’s in 1988. When Bill Clinton was president, his treasury secretaries – Lloyd Bentsen, Robert Rubin and Lawrence Summers were notably centrist and business-friendly. Economic populism only returned to the Democratic mainstream with the Al Gore campaign of 2000, and that may well be why he narrowly and unexpectedly lost to current President George W. Bush.

Sen. Clinton, on the other hand, already has proposed an economically nonsensical but populist idea – a gasoline-tax "holiday" for the peak summer driving season between Memorial Day and Labor Day, to be paid for from the profits of big oil companies. Such a tax change would tend to increase oil consumption, driving up prices, worsening any global warming and benefiting largely the mega-wealthy oil states of the Middle East and Venezuela.

The Sen. John McCain version of this proposal, without the attack on the oil companies, would be a subsidy from U.S. taxpayers to the oil sheiks; the Clinton version is a subsidy from the U.S. oil majors to the oil sheiks. Neither version makes much economic sense.

Obamanomics

Obama shares the Hillary Clinton flaw (from an investor viewpoint) of wanting to increase taxes – including capital gains taxes – at the top end of the scale. However, his healthcare plan would be somewhat cheaper (because it would mandate coverage only for children, not for everybody). And he’s more dovish on the Middle East, which may or may not be good policy, but is certainly likely to save money. On trade, Obama has echoed Clinton in protectionist Pennsylvania, but is believed to be generally more trade-friendly. He has notably failed to endorse the gasoline tax cut, describing it as a "classic Washington gimmick."

When it comes to policy, then, Obama beats Clinton in investor-friendliness, albeit not by very much.

However, the really difficult question to consider is the current state of the U.S. economy.

In 1993, the U.S. economy was emerging from a recession, with only the federal budget deficit as a major worry. On the positive side of the ledger, there were signs that the economic reforms of the 1980s had made the United States more competitive with the rest of the world. In that situation, government mostly needed to get out of the way and allow the boom to billow, and that’s essentially what President Bill Clinton did.

The 2008 version of the U.S. economy is much less clear. Indeed, the outlook is downright cloudy. Commodity and energy prices are at record levels and are likely to produce substantial consumer price inflation in the months ahead. Interest rates already are at exceptionally low levels – more than two percentage points below the rate of inflation – in order to cope with the U.S. economy’s continued financial crisis.

Housing is in a deep recession, with prices dropping more rapidly than at any time since the early 1930s. The dollar is weaker against other currencies than it has ever been, yet the United States still has a huge balance of payments deficit, suggesting it is less competitive than it should be. Stock prices, which in 1993 were at moderate levels, are today within 10% of their record highs, yet corporate earnings are declining, led largely by the disappearance of earnings from the financial sector.

Thus the economic situation today is far more difficult than it was back in 1993, and much more likely to produce "calls for government action" of one kind or another. Economic inaction, which worked so well for Bill Clinton, will not be a politically viable option today. What kind of action the government takes in response to those calls for action will have a huge effect on investor returns for the presidential term we are about to enter. For instance:

• Populist, economically nonsensical policies that include protectionism, heavy income redistribution and increased government spending will make that period a very difficult one indeed.
• Intelligent, carefully crafted policies that protect free trade, that avoid income redistribution and that provide only targeted increases in public spending may improve the situation somewhat. They will at least have the virtue of not making it worse, and of quieting the calls for more extreme policies that would be hugely damaging.

Given that choice, in today’s situation, my rooting preference would be for Sen. Obama.

[Editor's Note: Money Morning Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and Edwards, and concluded that Obama and McCain would be the best candidates for investors. He wrote about the "Potomac Primaries" in mid-February. For a full report on the "presidential profit plays," please click here. The report is free of charge].

News and Related Story Notes:

• Wikipedia:
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• Money Morning Election 2008 Investment Series:
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  Election 2008: U.S. Economy Cries "No mas" to the Democrats.

• Money Morning Election 2008 Investment Series:
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• Money Morning Election 2008 Investment Series:
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• Money Morning Election 2008 Investment Series:
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• Money Morning Special Investment Research Report:
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• Money Morning Election 2008 Investment Series:
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• Money Morning Election 2008 Investment Series:
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• Web Site:
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• Yahoo! Inc. Answers:
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• Money Morning Special Investment Research Report:
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By Martin Hutchinson
Contributing Editor

In Tuesday’s Pennsylvania Democratic Presidential Primary, Sen. Hillary Rodham Clinton achieved the absolute bare minimum she needed to prolong her battle against Barack Obama. And she still had a slight hope of somehow squeaking through to land the party nomination.

But that’s not the "real" story here.

In view of the irresponsible and damaging economic promises that are emerging from both contenders, the already-wheezing U.S. economy may be about to cry for mercy from the relentless and prolonged assault. And the longer the Democratic Primary War continues, the greater the fallout for the U.S. market.

We all understand the dynamics of U.S. presidential politics. In the primaries, contenders make promises designed to appeal to the most-committed, core supporters of their party. Republicans promise tax cuts so massive that they would immediately put the Federal budget into terminal collapse; they promise extra military programs; and they talk about a new batch of moral initiatives designed to make U.S. teenagers straighten up – once and for all.

Democrats, on the other hand, promise an impenetrable wall against foreigners taking away high-paying union jobs; plus social programs designed to rescue anybody suffering financial or emotional difficulties; and a spectacular new environmental assault against multinational corporations that will return the entire planet to room temperature.

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Only the most simple-minded voters take these pledges seriously. The problem is that once the candidate is elected, some percentage of their campaign "promises" will need to be put into effect – presumably in order to reassure voters about the high integrity of politicians. Make 10 pledges, you can get away with implementing two; make 50, and you will have to implement at least seven or eight, if not 10.

Once the primary season is over, the game changes. Now the candidates are looking for the elusive "soccer mom" independent, who has all kinds of needs and desires but who above all wants to be reassured that the next president won’t do anything rash or expensive, because it might cost too much money or damage the economy.

The focus goes on to tiny little non-partisan initiatives, exquisitely crafted to win a particular voting bloc, but each only moderately expensive and hardly any of them economically damaging. More of these have to be implemented after the election – maybe 5 out of each 10 – so their aggregate effect is quite expensive and damaging, but no one initiative can be blamed for this problem.

Then, after the election, the politicians go back to rewarding large campaign donors and potential campaign donors in the usual ways, with the occasional populist panic when a crisis occurs.

The problem now is that the Clinton/Obama primary contest has gone on too long.

On trade, both candidates, who had been considered fairly moderate and rational, have already:

• Come out against a perfectly benign free trade agreement with Colombia.
• Have promised to renegotiate the North American Free Trade Agreement (NAFTA), already in effect for 14 years.
• And have made threatening noises against the evil multinationals that "outsource" good U.S. jobs to Third World markets.

Obama, for example, has proposed substantial tax breaks for those "Patriot" companies that keep jobs in the United States, and that pay union wages and benefits. If either candidate is elected, and puts into effect half of the protectionist policies they have supported, world trade will be thoroughly obstructed, and will probably decline in total. That’s a highly undesirable outcome; the only time we’ve seen this previously was in the 1930s.

Then there’s housing. Both candidates want to spend at least $30 billion to bail out the scorched U.S. housing market, helping defaulting homeowners through federally guaranteed loans that forgive part of the principal. Clinton even wants to add a feature, proposing the government buy foreclosed houses in the hope of reselling them later on.

This would all create an artificial price floor under the housing market, which sounds like a good idea until you realize that since the market prices would be artificial, there would be few free-market buyers supporting the market. That "reality" brings with it a high probability of a further downward lurch in home prices that could devastate market confidence and damage the U.S. housing market for years – if not decades – to come.

Both candidates have healthcare plans, and are currently accusing each other of being too mean to consumers. Only on the subject of taxation does the competition not run to who can give the biggest benefits; here the argument is who is calling for the bigger tax increase for the rich – sticking it to the rich is a key aim of many Democrat primary voters, however counterproductive it may be economically.

Once Clinton or Obama has been anointed as the Democratic nominee, the rhetoric will change radically. Gone will be all the hostility to multinationals, foreign competitors and those of higher incomes. Likewise, you’ll also be able to watch and see as the lavish handouts to subprime homeowners and the uninsured suddenly disappear.

In will come soothing statements about the candidate’s commitment to world trade and fiscal responsibility, combined with explanations of how their health and housing plans will be carefully targeted at those most in need.

From the U.S. economy’s point of view, that day cannot come soon enough.

[Editor's Note: Money Morning Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and Edwards, and concluded that Obama and McCain would be the best candidates for investors. He wrote about the "Potomac Primaries" in mid-February. For a full report on the "presidential profit plays," please click here. The report is free of charge].

News and Related Story Notes:

• Wikipedia:
  North American Free Trade Agreement

• Money Morning Election 2008 Investment Series:
  Which Republican Candidates Will Be Best For Investor Profits

• Money Morning Election 2008 Investment Series:
  Which Democratic Candidates Will Be Best For Investor Profits

• Money Morning Election 2008 Investment Series:
  After Super Tuesday Downer, Investors Seek Answers in Today’s "Potomac Primaries"

• Money Morning Special Investment Research Report:
  Now That Warren Buffett is Crazy About the Loonie, Here are Seven Ways to Profit From a Strong Canadian Dollar

• Money Morning Election 2008 Investment Series:
  The Six Profit Plays to Consider as "Super Tuesday" Plays Out

• Money Morning Election 2008 Investment Series:
  Election 2008: Drawn-Out Dems Battle Could be Bad for Investors.

Hillary Rodham Clinton’s unexpected primary victories in Ohio and Texas this week bring the prospect of a further lengthy struggle for the Democrat nomination.

Normally, investors shouldn’t care – especially Republicans. The sight of Democratic candidates beating each other with saucepans for months on end brings innocent enjoyment to watchers, gainful employment to political pundits and journalists, and a modest improvement to Republican chances in November.

This time around, with the prospect of a protracted Democratic tussle, investors unfortunately have a cause for concern.

Over the next months, Clinton and Barack Obama will struggle for the few remaining primary delegates. In doing so, they will be drawn to appeal to the less educated, less-economically literate voters by making populist promises that make no economic sense, but still attract votes. We have already seen where that leads: Obama in Ohio denounced the North American Free Trade Agreement, promising to "use the hammer of a potential opt-out as leverage to ensure that we actually get labor and environmental standards that are enforced." Whether or not Obama succeeded in renegotiating or ending NAFTA, you have to worry about what such tactics would do to U.S. relations with Canada, a friendly country, sensitive to U.S. bullying, and the largest U.S. oil supplier.

Investors know that the economic differences between the two parties generally don’t matter all that much, although there will be different profit plays to make depending upon whether a Democrat or a Republican wins the White House.

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For instance, investors know that taxes will be higher if a Democrat wins, and that certain industries, notably defense contractors and pharmaceutical companies, tend to do better under Republicans. But a sensible investor recognizes that in a two-party system, the other side is going to win from time to time; indeed, an opposition victory may be a useful rebuke for a lousy performance by the party that you support.

For example, the British Conservatives would almost certainly have benefited had John Major lost the 1992 election to the unpopular Neil Kinnock. By working to win the election for Major, party activists condemned themselves to five more years of thoroughly inept government, during which party principles were repeatedly trashed, followed by more than a decade of opposition, after a revived and reformed Labor party cemented itself in power under Tony Blair.

In this case, however, both Clinton and Obama are showing signs of abandoning the traditional Democrat commitment to free trade. Free trade is an arcane economic issue, because its benefits are wide but spread very thin, so it’s difficult for investors to make money off it. However, a move towards protectionism – for example, by renegotiating NAFTA as both Clinton and Obama suggest – would raise trade barriers that had been lowered and disrupt trade relationships that had settled into place after NAFTA passed in 1994.

To understand just how damaging that would be, just look back into history. Before 1914, Austria-Hungary was one of the more-prosperous regions of Europe, with relatively poor farming communities at its eastern border offset by the enormously wealthy cities of Vienna and Budapest, from which an astounding percentage of 20th Century culture, thought and science emerged. The so-called "Austro-Hungarian Empire" benefited from being more or less a free trade zone of 100 million people of varying languages and nationalities.

Following Germany’s defeat at the end of World War I, Austria-Hungary was broken up, by the vindictive Treaty of Versailles, and reorganized into small states – Czechoslovakia, Austria, Hungary and Yugoslavia – that no longer had free trade relationships with each other. The barriers that had been put in place proved ruinous for the region’s prosperity. At least initially, Czechoslovakia didn’t fare so badly [though it ultimately fell prey to the envy of its German neighbor].

However, Austria was impoverished and turned Nazi. Hungary was impoverished and fell under a dictatorship. Not to be outdone, an impoverished Yugoslavia fell to both Nazism and Communism in different regions. The collapse of pre-1914 trading relationships worldwide was a major cause of the Great Depression and World War II. With Austria-Hungary, the creation of trade barriers caused impoverishment on a local scale that was so deep-seated that it didn’t even start to lift until after those countries resumed unfettered trading after 1989.

Similarly, a lengthy primary campaign would cement protectionist policies in place among the leading Democrat candidates, and increase the probability of them following protectionist policies if elected. The principal losers from such protectionism would be those companies whose operations are located throughout NAFTA-member countries, or are situated across the world, in general. The U.S. auto industry’s Big Three – General Motors Corp. (GM), Ford Motor Co. (F) and Chrysler LLC – each have major manufacturing operations in both Canada and Mexico, and supply the North American market on an integrated basis. The elimination of NAFTA would land yet another blow on those already-staggering enterprises.

Similarly, software giant Microsoft Corp. (MSFT) has operations all over the world, while The Boeing Co. (BA) – the largest U.S. exporter – has promoted foreign-supplier relationships specifically to improve its ability to sell aircraft in many markets around the world.

For investors, President Barack Obama or President Hilary Rodham Clinton would be but a moderate worry. But a protracted and savage primary campaign between the two – in which populist and economically damaging promises were made that later became actual policies – would be a massive market downer.

[Editor's Note: Money Morning Contributing Editor Martin Hutchinson has personally interviewed the economic advisors for candidates McCain, Obama and Edwards, and concluded that Obama and McCain would be the best candidates for investors. He last wrote about the "Potomac Primaries" in mid-February. For a full report on the "presidential profit plays," please click here. The report is free of charge].

News and Related Story Notes:

• Wikipedia:
  North American Free Trade Agreement

• Money Morning Election 2008 Investment Series:
  Which Republican Candidates Will Be Best For Investor Profits

• Money Morning Election 2008 Investment Series:
  Which Democratic Candidates Will Be Best For Investor Profits

• Money Morning Election 2008 Investment Series:
  After Super Tuesday Downer, Investors Seek Answers in Today’s "Potomac Primaries"

• Money Morning Special Investment Research Report:
  Now That Warren Buffett is Crazy About the Loonie, Here are Seven Ways to Profit From a Strong Canadian Dollar

• Money Morning Election 2008 Investment Series:
  The Six Profit Plays to Consider as "Super Tuesday" Plays Out 

By Martin Hutchinson
Contributing Editor

Super Tuesday has come and gone, and for investors who want to keep a decent share of their hard won dividends and capital gains, the news isn’t good. The most investor-friendly candidates have pretty much been eliminated from the race, and we’re left trying to craft a strategy that allows us to survive and even profit no matter which of the remaining candidates finally makes it to the top of the pile in November.

On the Republican side, the picture is pretty clear. Ron Paul was unquestionably the most investor-friendly candidate based on the fact that his plans to downsize the government and end the United States’ Middle East involvement would both increase the resources available for the private sector and reduce the burden on taxpayers. However, he was never likely to go anywhere, if only because his foreign policy was unanimously opposed by the party bigwigs. Rudy Giuliani was also pro-investor, but got nowhere, and the same was true of Congressman and Law & Order star Fred Thompson.

Republican Realities

Because of that, the reality was that by Super Tuesday, the party’s Bloomingdales-like profusion of attractive candidates – each with rather different advantages that had been displayed a month ago in Iowa – has been reduced to a display that more-resembled a Soviet-era GUM store, with bare shelves, a bickering staff and a general disregard for the wishes of the investor/voter/consumer.

On Super Tuesday, the most investor-friendly candidate, Mitt Romney, did poorly, while the least investor-friendly candidate, Mike Huckabee, did much better than expected. In the end, we were left with the virtual certainty that the final nominee would be John McCain. Subsequently, Romney pulled out of the race and the primaries and caucuses held over the weekend have left Huckabee fighting a rearguard battle to stop McCain. However, most of the party bigwigs have already endorsed McCain, so he is the likely nominee.

McCain has his strengths. His economic advisor, Douglas Holtz-Eakin, former head of the Congressional Budget Office, has a firm grip on the nature of the fiscal train-wreck that is approaching us in the next decade or so. Given that the current incumbent is proposing a budget with the highest spending since 1994, and within $3 billion of the highest deficit ever, this will be a big plus. Make no mistake about it: If the U.S. economy chugs into a recession pulling railcars loaded with a $400 billion deficit, the budgetary shortfall will soar to $1 trillion before we know what happened.

At least McCain’s advisors understand this, meaning he has the best chance of preventing that $1 trillion deficit from sweeping away the bond market and causing irreparable damage to the U.S. economy as a whole.

Having said that, you have pretty well exhausted McCain’s advantages. He has no great objection to higher taxes, so we will undoubtedly get them [we will under the Democrats too, but tax increases by Democrats leave the promise of being reversed next time the Republicans win the White House, while tax increases by a President McCain make no such promise]. McCain also has a visceral objection to both Wall Street and the pharmaceutical industry, and no great commitment to the private sector as a whole.

Romney may have been a dislikeable guy, but to cast rocks at him for working for a private equity fund, or for having friends on Wall Street, is not encouraging in a potential Republican presidential nominee. You might thus see some other investor-unfriendly laws passed – for example a transactions tax on share dealings, or a return to the days when there was a heavy reliance on the estate tax for revenue, abandoning the Bush Administration’s plan to end the estate tax in 2011.

You probably wouldn’t want to be invested in financial services companies or pharmaceuticals with McCain as U.S. president.

Decision Time for Democrats

Turning now to the Democrats, the picture is much less clear. Barack Obama ran Hillary Rodham Clinton nearly equal in terms of delegates, which was a very strong performance – especially since the states being contested included her previous home state of Arkansas and her current adopted home state of New York. Subsequently, Obama won a bunch of primaries and caucuses at the weekend, by handy majorities. If the pundits prove correct in their belief that the primaries today (Tuesday) in Maryland, the District of Columbia and Virginia on February 12 are natural Obama country, he is likely to have a substantial delegate lead after those states vote.

Clinton apparently likes her chances in Texas and Ohio in early March, and in Pennsylvania in late April, but Obama’s candidacy seems to be picking up speed, and he may be able to neutralize her advantage in those states.

If he’s able to achieve that, his main problem then will be the 800 super-delegates – selected separately by party leaders – which might be expected to favor the establishment candidate Clinton. However, since Obama has attracted the support of Edward Kennedy and a number of other party bigwigs, Clinton’s advantage there may not be so great, either.

In short, the outcome is still uncertain, but the probabilities are about 65-35 for Obama.

Key Considerations for U.S. Investors

If Clinton is the Democrat nominee, November’s election should be a close one, possibly with the intervention of a third-party candidate. Her negatives are sufficiently strong that even those Republicans who dislike McCain will end up voting for him [yes, possibly even including Ann Coulter, who has sworn to support Clinton!].

As president, Clinton would introduce a healthcare plan with a universal mandate, which would probably be heavily skewed towards the public sector, relying on government controls to keep costs down. That would introduce government inefficiency into a huge additional swathe of the U.S. economy, raising taxes and costs and reducing economic growth.

Obama, by contrast, is temperamentally more free market oriented; for example, his health plan contains a mandate that is universal only for children. Like Clinton, he would raise taxes, and concentrate tax relief on those at the lower end of the income scale, but his generally market-oriented approach to healthcare would lessen the dangers of introducing major un-competitiveness into the U.S. economy. He is also more determined than Clinton to end the U.S. involvement in Iraq, which might provide further savings that would limit the potential tax increases. You could certainly argue that a President Obama would be more pro-investor than a President McCain; an Obama presidency would have the additional advantage that there was always the possibility of a Republican return to power afterwards on a free-market platform.

For investors, the picture is bleak, but not yet entirely clear. A McCain presidency would probably be the least inflationary, and the least likely to produce a runaway budget deficit; that might suggest an investment in bonds. An Obama presidency would probably not damage the free market excessively, but you wouldn’t want to own defense stocks. A Clinton presidency is probably bad news for investors, particularly if her protectionist instincts caused her to inflict damage on the world’s fragile trading system.

To avoid U.S. political risk, the remedy is simple: Put your money in Asia.

[Editor’s Note: In our last installment in this series, Managing Editor Jennifer Yousfi penned an investor-oriented preview of Super Tuesday. For an overview of all the candidates and their implications for investors, click here to read Election 2008: Which Republican Candidates Will Be Best For Investor Profits and Election 2008: Which Democratic Candidates Will Be Best For Investor Profits.

News and Related Story Links:

• Wikipedia:
  Soviet Main Universal (GUM) Stores

• National Review Online:
  The Verdict of Super Tuesday

• Money Morning Investment Research Report:
  Election 2008: Which Republican Candidates Will Be Best For Investor Profits

• Money Morning Investment Research Report:
  Election 2008: Which Democratic Candidates Will Be Best For Investor Profits

• Money Morning News Analysis:
  The Six Profit Plays to Consider as "Super Tuesday" Plays Out

By Martin Hutchinson
Contributing Editor

With the Iowa caucuses set for tonight (Thursday), it’s worthwhile for investors to consider which politicians might make your life easier, and who might make a grab for your hard-fought investment gains.

And let’s be honest: It’s worth a look to see if we can figure out how to capitalize on the election results – whatever they may be.

This is the second of two pieces in which I look at the presidential candidates’ economic proposals.  In the last piece, I looked at Democratic candidates Hillary Rodham Clinton, John Edwards and Barack Obama, and concluded on balance that Obama was the most investor-friendly. In this piece I look at the large-and-confused Republican field, in which Rudy Giuliani, Mike Huckabee, John McCain, Ron Paul, Mitt Romney and Fred Thompson each have their strengths, yet none can be regarded as a true front-runner.

The Republican Roundup

As New York mayor, Rudy Giuliani became a national hero during the 9/11 terrorist attacks. Now, as a presidential candidate, Giuliani has modest-but-sensible tax and economic policies. He worries about the abysmal U.S. savings rate, and favors tax-deferred savings accounts to increase it. He doesn’t plan to introduce a "cap-and-trade" system of emissions controls to combat global warming and he wants to develop a constitutional line-item veto. He also wants to introduce competition – into healthcare insurance, by allowing consumers to buy insurance across state boundaries, and into education, through vouchers. He would keep the Bush Administration tax cuts. And, of course he has an excellent executive track record of sound fiscal management in difficult circumstances as the mayor of New York City.

The problem is foreign policy, where Giuliani has surrounded himself with neoconservatives, now out of favor in Washington because of the difficulties following the Iraq invasion, which they sponsored. Indeed, Giuliani’s leading foreign policy advisor, Norman Podhoretz, is one of the founding fathers of the so-called "neo-con" movement. However, one worries that an aggressive neo-con Middle East policy – when combined with Giuliani’s well-known mercurial temperament – could prove very expensive.

Even the title of Podhoretz’s latest book, World War IV – The Long Struggle Against Islamofascism, sounds thoroughly unaffordable.

Mike Huckabee, a Baptist minister and former governor of Arkansas, frequently invokes God in his campaigning. The trouble is, God will also have to intercede once Huckabee is elected, for divine intervention is the only way this candidate’s economic policies will work. His "fair tax" plan – the principal proposal distinguishing his ideas from those of former President Jimmy Carter – is a consumption tax at a very high rate, and would supposedly replace the existing personal income tax. This would tax the poor more than the rich [because the poor save less] and would also sharply increase the cost of housing and medical services – already two of today’s biggest economic problems.

Worst of all, this new tax plan would spur widespread evasion. Huckabee’s federal ban on smoking wouldn’t end smoking, any more than the Volstead Act [more popularly known as Prohibition] ended drinking; it would merely eradicate $30 billion in tax revenue from federal and state governments – much of which is being used to finance healthcare programs. His plan for complete self-sufficiency in energy within eight years – the United States is currently only 69% self-sufficient – would probably require him to remove the sparkplugs from all of America’s automobiles.

Economically, Huckabee is just not ready for the prime time.

John McCain is the "root canal" candidate – his economic slogan might as well be: "Vote McCain – Enjoy the Pain!" He would keep most – but not all – of the Bush tax cuts, would attack pork barrel spending aggressively, would abolish ethanol subsidies, and would sharply reduce agriculture subsidies [and, yet, he actually does have some supporters in Iowa!]. McCain is a strong supporter of free trade, even when U.S. jobs are lost, and favors an aggressive approach to eliminating the future deficits posed by Social Security and Medicare. He would also introduce a "cap-and-trade" system of carbon-emissions permits, giving the government an additional source of revenue.

So, if getting rid of the federal budget deficit and reducing the burden of debt on our grandchildren is your No. 1 priority, McCain is your man.

Ron Paul has no executive experience, having held office only as a congressman [though senators McCain and Thompson also have no executive experience, either]. Paul is the only candidate taking a truly logical approach to small government, believing it should be small internationally as well as domestically – after all, the Iraq War’s annual expenses, alone, exceed 1% of U.S. gross domestic product (GDP). In general, Paul best represents truly traditional Republicanism, that of the small government President Calvin Coolidge [though, unlike Coolidge, Paul favors free trade].

Paul would eliminate such corporate welfare programs as subsidies for agriculture and ethanol, would provide education vouchers and offer tax credits for home schooling, would introduce Health Savings Accounts, and would eliminate restrictions on insurance coverage to make healthcare more efficient. He would also abolish several government departments and all agencies that engage in the "takings" of private property.

Paul is also the only candidate to criticize the U.S. Federal Reserve, since he believes that a Gold Standard is the ideal monetary system, but that a Paul Volcker-style Fed, which keeps monetary policy tight, is the next best thing. In Paul’s view the dot-com and housing bubbles were huge and preventable wastes of resources. Internationally, he would pull the United States out of Iraq, but would also pull out of most international agencies and other entanglements. While Democrats are multilateralist in foreign policy, Paul is largely isolationist.

In spite of his vociferous student support and impressive Internet fundraising, Paul won’t win. But his ideas may provide a roadmap for a more-successful campaign in the future.

Mitt Romney’s economic policies are mostly a conservative "wish list." However, when really scrutinized, it’s easy to see that they’re unlikely to pass muster with Congress. Romney wants to eliminate capital gains taxes on incomes under $200,000. And not only does he want a line-item veto to restrain Congressional spending, Romney also wants the right to reduce any Congressional appropriation by up to 25% [this is probably unconstitutional] and to require a 60% vote in Congress to increase taxes. He would also hold appropriations growth to 1% below inflation by using the veto [a very tight limit when compared with the 3% to 4% real growth under current U.S. President George W. Bush]. Romney would increase military spending by 10%, putting another 100,000 troops in uniform.

All wonderful stuff. However, once he discovered that these policies stood no chance whatsoever of passing even a Congress with a large Republican majority [because several of these proposals are direct assaults on the legislative branch's power - regardless of which party controls Congress], Romney would have two choices: Keep banging his head against a wall, or fall back on the philosophy he employed as the governor of Massachusetts, and that his father employed as the governor of Michigan – transforming himself into a conventional, big-spending liberal Republican of the 1960s.

Frankly, I’d rather know what I’m getting when I elect someone to the White House.

Former Congressman and Law and Order star Fred Thompson has an interesting tax plan, under which we would get to choose whether we pay the current income tax, or a simplified flat tax with rates of 10% up to $100,000, and 25% above that figure. That sounds fine, until you work out the cost of allowing taxpayers to choose which tax they wish to pay. If we extrapolate from the estimated $80 billion annual cost of removing the Alternative Minimum Tax, or AMT [in which the government gets the option of determining which tax you pay], it seems likely that Thompson’s tax proposal would reduce revenue by around $200 billion per annum. Since there are no significant savings elsewhere in his economic platform, that would throw the federal budget seriously out of whack. Fred: We give you a B+ for innovation and effort, but a D- for basic arithmetic!

How to Profit from a Republican Regime

• Defense stocks would probably perform superbly under a Giuliani administration and fairly well under other Republicans – except Ron Paul, who would make them tumble.

• Investors who believe a Republican will be elected should look at the pharmaceutical, healthcare and financial-services sectors, all of which would be damaged by a Democratic victory. Investors believing a Republican will take the White House should also look at domestic oil companies and oil-service companies, since the Republicans seek to encourage domestic oil exploration.

• Utilities with large nuclear operations would benefit under McCain. 

• Treasury bond prices would probably drop under Huckabee or Thompson, chiefly because of the uncertainty of their arithmetic. Giuliani and Romney might also run into deficit problems. McCain, balancing the budget, and Paul, reducing both inflation and the size of government, would both be good for Treasuries.

• Paul’s high interest rates and budget cutting would punish stocks in the short run, but benefit them in the long term.

• Tobacco companies and purveyors of junk food would suffer under Huckabee, while you wouldn’t legally able to invest in the "tobacco bootleggers" who would make huge fortunes.

Ron Paul has the most investor-friendly economic policies in the long run. If you think he can’t win and want a "serious" candidate, the best bets among the Republicans are McCain [but brace yourself for fiscal pain] or Giuliani [and cross your fingers].

Editor’s Note: Money Morning Contributing EditorMartin Hutchinson has been chronicling the economic platforms of the presidential candidates, and has had personal interviews with economic advisors for candidates McCain, Obama and Edwards. His analysis of the Democratic candidates appeared just before the holidays.

Election 2008: How Each Party Will Impact the U.S. Economy and the Domestic Stock Market

By Martin Hutchinson
Contributing Editor

Democratic presidential victories can generally be regarded as moderately bad news for U.S. investors, especially because of their generally higher tax levels on the higher-income classes. There are some notable exceptions, of course, including President Bill Clinton, where a huge bull market in stocks more than counterbalanced the draining impact of higher taxes.

This time around, apart from taxes, there appear to be two major differences between the Democrats and Republicans:

• The Democrats support a universal healthcare provision.
• And the Democrats favor a greater degree of protectionism.

The United States spends about 16% of its gross domestic product (GDP) on healthcare, of which about 7% is funded by the government. Ominously, healthcare expenditures have increased over the past 30 years at a rate that’s consistently 2.5% faster than the growth rate of GDP. What’s more, U.S. healthcare outcomes [how long we live and how sick we are while we're alive] are no better than in Japan, or than they are in several European countries where healthcare spending is only 11% to 12% of GDP. That suggests that one of the principal U.S. healthcare problems is inefficiency: We have more expensive doctors, more bloated bureaucracies [particularly those in the insurance arena] and greedier hospitals. The best solution to the problem might well increase the state provision, but also would certainly make substantial inroads on the cost side.

Given the current figures, it seems inconceivable that government could provide a "universal" healthcare provision to lower-income groups for less than 10% to 11% of GDP – or about 3% to 4% of GDP more than government is currently spending. That implies that the true long-term annual cost of such a provision might well be a net $400 billion to $500 billion. Thus, the assurances by Democratic candidates that their healthcare plans would cost "only" $100 billion to $120 billion are to be regarded with suspicion.

The second area where Democratic policies should spawn investor concern is international trade. Historically, the Democrats have been the party more committed to free trade, right back to the Civil War. After all, it was Republican president Herbert Hoover who signed the notorious 1930 Smoot-Hawley Tariff Act, which is now believed to have killed off world trade and prolonged the Great Depression, while it was Democratic president Harry S Truman who pushed for the first General Agreement on Tariffs and Trade (the forerunner of the World Trade Organization) in 1947 and Clinton, another Democrat, who signed the North American Free Trade Agreement in 1994.

However, all three major Democrat candidates are far more protectionist than Clinton; indeed even Hillary Clinton has repudiated Bill’s signal achievement of NAFTA. Thus, a Democrat president might well institute a number of "anti-dumping" actions, such as Senator Charles Schumer’s (D-NY) 27% tariffs on imports from China.

The trouble with such strategies is that they aren’t executed in a vacuum. The target – in this case, China – naturally retaliates with tariffs or other trade barriers of their own, the controversy escalates further on both sides, and soon all the benefits of global trade to the world economy are lost to all.

While workers in uncompetitive industries might keep their jobs a few years longer, world economic growth would be much slower, and world stock prices [i.e. our investments] would be correspondingly reduced in value.

On the other hand, there are some likely benefits to investors from a Democrat victory in 2008.  On foreign policy, two of the three top Democrat candidates are likely to get the United States out of Iraq quickly, and to spend less overall on projecting U.S. power worldwide. This might, or might not be, a good strategy against global terrorism, but it would certainly save the cost of the Iraq war – which equates to about $170 billion per annum, or 1.2% of GDP. Since the Democrats also plan to reverse the Bush tax cuts, even if their healthcare plans prove unexpectedly expensive, they are unlikely to run much bigger budget deficits than the Republicans.

News and Related Story Links:

• Money Morning Presidential Campaign Analysis:
  Election 2008: Which Democratic Candidates Will Be Best For Investor Profits.

• Newsday:
  House OKs alternative minimum tax exemption increase.

• FoxNews.com:
  FOX News Poll: Clinton Retains Double-Digit Edge Over Obama Nationally.

• Wikipedia:
  Hilary Rodham Clinton.

• Wikipedia:
  John Edwards.

• Whitehouse.gov:
  Calvin Coolidge.

• Wikipedia:
  Barack Obama.

• Wikipedia:
  Emissions Controls (Cap and Trade).

• Whitehouse.gov:
  William J. (Bill) Clinton.

• Wikipedia:
  Education Vouchers.

• Wikipedia:
  Rudy Giuliani.

• Money Morning News Analysis:
  China’s Record Trade Surplus Again Inflames U.S. Criticism.

• Wikipedia:
  John McCain.

• Wikipedia:
  Ron Paul.

• Wikipedia: 
  Mitt Romney.

• Wikipedia:
  Fred Thompson.

• Wikipedia:
  Super Tuesday.

• Christian Science Monitor:
  Neocon 101.

• Wikipedia:
  North American Free Trade Agreement.

• Wikipedia:
  Norman Podhoretz.

• Wikipedia:
  President Jimmy Carter.

By Martin Hutchinson
Contributing Editor

With the Iowa caucuses looming immediately after the New Year’s holiday it’s worthwhile for investors to take a break from their trading triumphs and focus on politics. It’s worth taking the time to determine which politicians might make your life easier, and who might be grasping at your hard-earned profits.

And let’s be honest: It’s worth a look to see if we can figure out how to capitalize on the election results – whatever they may be.

In this piece, I am going to look at leading Democratic candidates, Hillary Rodham Clinton, John Edwards and Barack Obama. Then, in my next piece, I shall look at the large-and-confused Republican field, in which Rudy Giuliani, Mike Huckabee, John McCain, Ron Paul, Mitt Romney and Fred Thompson each have their strengths, yet none can be regarded as a true front-runner. Unlike some previous years, there is little overlap between the economic policies of the two parties, yet the candidate who emerges from each party can potentially affect the long-term U.S. economic outlook as much as the ultimate victor of the November 2008 presidential election.

A Wide Open Election

For voters, this is shaping up to be one of the most confusing elections in many years. For one thing, there is no incumbent. And neither party has a clear front-runner, whose upset would come as a major shock [although in a FoxNews poll released yesterday (Thursday), Democrats back Clinton over Obama 49% to 20%].

Back in the 2004 presidential primaries, only the Democrats had a competitive contest; in 2000, both George W. Bush and Al Gore were almost completely assured of their respective parties’ nominations – fully 18 months before the election.

But this time around, the Democrat field is fairly open and the Republican field completely open, with no clear front-runner at all. There looks to be a very good possibility that we will not be done with primary electioneering on the "Super Tuesday" of Feb. 5, but that each later primary contest will be meaningful right up to the end. In fact, it’s even possible we’ll end up with a brokered convention for one of the candidates – in August for the Democrats, or early September for the Republicans – with deals being done in back rooms, and only the lack of cigar smoke to remind us that we are not about to elect Warren G. Harding as president.

Let’s turn to the candidates.

Dialing for Democrats

Hillary Clinton is by far the most vague about her economic proposals. She would remove the Bush tax cuts on incomes over $200,000, but has not said what she plans to do about Social Security or for the highly problematic Alternative Minimum Tax (AMT). Her support of a "cap-and-trade" carbon-emissions-permit scheme to combat global warming should provide substantial additional government revenue, even as it boosts costs for business.

On the other hand, Sen. Clinton plans two new tax credit schemes for education and retirement saving, both of which would be expensive. In terms of government spending, her healthcare plan is comprehensive, but she won’t commit to removing troops from Iraq before 2013. That means she has a diminished ability to pay for healthcare without substantially higher taxes.

Clinton opposes all the recent free trade agreements except for the Peru deal, which passed the Senate recently by 77-19, and has said the North American Free Trade Agreement (NAFTA) needs to be "revisited."

John Edwards, fairly centrist during his Senate career, is running as the out and out populist this time. He plans to remove the Bush tax cuts and institute Social Security contributions for those with incomes of greater than $200,000. And he supports the AMT tax-reform plan of U.S. Rep. Charles B. Rangel (D-NY), which would raise income tax on high earners by another 4.6%. As a result of Edwards’ two proposals, high-earners would see their marginal tax rates increase from the current 35% to 50.2% — and actually more than 60%, if state taxes are included. This huge increase would certainly have an adverse supply side effect.

Edwards is also running as the populist on trade. He maintains that the entire U.S. trade deficit can be eliminated with three key moves:

• By imposing anti-dumping duties on China.
• By boosting conservation and with domestic-energy sourcing [although he opposes nuclear power].
• And through greater trade retaliation.

Since Edwards would pull our troops out of Iraq immediately, and proposes more tax increases than Hillary Clinton, an Edwards-led administration would presumably run a smaller budget deficit – excluding the probable substantial adverse economic effects of his tax-and-trade proposals.

Barack Obama is campaigning to Clinton’s left when it comes to Iraq [he wants to get out more quickly], but he is more moderate when it comes to his economic policies.

Obama contends that economic growth since 2000 has gone almost entirely to the top 5% of the population, and therefore wants to direct tax cuts toward moderate-income earners. However, he is opposed to "class warfare" rhetoric, or taxation. While favoring ending the Bush tax cuts for taxpayers with incomes in excess of $200,000, introducing social security contributions on high incomes and favoring the Rangel plan to replace the AMT, he recognizes that if all three changes are made, marginal tax rates would soar – meaning some compromise must be found.

Obama’s healthcare proposal is less expensive than those of Clinton or Edwards because its "universal mandate" would extend only to children. Further, he recognizes the ability of market incentives to reduce costs, and wants to avoid federalizing U.S. healthcare. Like other candidates, he favors a "cap-and-trade" carbon-emissions-permit system, but he regards nuclear power as an important part of the solution to the problem of global warming. He regards bilateral trade treaties as corrupt, but favors multilateral treaties, albeit with strong protections for both labor and the environment.

How to Profit From A Democratic Administration

While there’s no "one-size-fits-all" investing strategy for the Democratic slate, there are some key considerations to keep in mind as you craft your investment moves between now and the presidential elections next November. These are the ones that we believe are key:

• Investors who believe a Democrat will be elected should avoid the pharmaceutical, healthcare and financial-services sectors, all of which are likely to suffer with a Democrat in the White House. On the other hand, low-end retailers and manufacturers of low-end domestic automobiles and consumer goods would probably be substantial beneficiaries.

• Defense stocks would do fine under Clinton, but less well under Edwards or Obama. 

• Utilities with large nuclear operations would benefit under Obama, but not under Edwards [Clinton's position is currently unclear]. 

• Treasury bond prices would suffer under Clinton – and probably Edwards – because of probable larger budget deficits. That would not be the case under Obama.

• An Edwards victory would probably make it worthwhile going short on a global stock index, because investors would be highly worried about the potential impact his trade policies might have on world trade and the global economy.

Overall, since Obama is cheaper than Clinton on healthcare and foreign policy, and less likely to start a major trade war than Edwards, he’s the most investor-friendly Democratic candidate.

Election 2008: How the Two Parties Compare Economically


By Martin Hutchinson

Contributing Editor

Because Democrats like to tax the affluent, Democratic presidential victories are typically regarded as moderately bad news for the investor class. There are exceptions, of course, such as was the case with President Bill Clinton, where this higher-tax effect was more than counterbalanced by a huge stock-market boom.

This time around, however, apart from taxes, there appear to be two major differences between the economic policies of the two parties: The Democrats support a universal healthcare provision, and a greater degree of protectionism.

In the United States, we spend about 16% of our Gross Domestic Product (GDP) on healthcare, of which about 7% is provided by the government. In a most-ominous note, over the past 30 years, healthcare has expanded at an annual rate that’s about 2.5% faster than GDP.  What’s more, U.S. healthcare outcomes [i.e. how long we live and how sick we are during our lifetimes] are no better than in Japan or several European countries, where healthcare spending is only 11%-12% of GDP.

That suggests that one of the principal U.S. healthcare problems is inefficiency: more-expensive doctors, more overstuffed bureaucracies [including those in insurance] and greedier hospitals. The best solution to the problem might well increase the state provision, but would certainly make substantial inroads on the cost side.

Given the current figures, it seems unimaginable that government can provide "universal" healthcare to lower-income groups for less than 10%-11% of GDP, which is about 3%-4% of GDP more than government is currently spending. That implies that the true long-term annual cost of such provision might be a net $400 to $500 billion. Thus, assurances by Democratic candidates that their healthcare plans will cost "only" $100 billion to $120 billion should be regarded with suspicion.

The second locus of concern when it comes to Democratic candidates is international trade. Historically, the Democratic party has been the one that’s more favorable to free trade – a truism that reaches all the way back to the U.S. Civil War. After all, it was Republican President Herbert Hoover who signed the notorious 1930 Smoot-Hawley tariff, which many experts now believe helped kill off world trade and prolong the Great Depression.

By comparison, it was Democrat President Harry S Truman who pushed for the first General Agreement on Tariffs and Trade (the forerunner of the World Trade Organization) in 1947, and it was Democrat president Bill Clinton who signed the NAFTA deal in 1994.

However, all three major Democratic candidates are far more protectionist than Bill Clinton; indeed, even Hillary Clinton has repudiated her husband’s headline achievement of NAFTA. Thus, a Democratic president might well institute a number of "anti-dumping" actions, such as the proposal by U.S. Sen. Charles Schumer (D-NY) to impose 27% tariffs on imports from China.

The trouble with such strategies is that they aren’t executed in a vacuum. The target – in this case, China – naturally retaliates with tariffs or other trade barriers of their own, the controversy escalates further on both sides, and soon all the benefits of global trade to the world economy are lost to all.

While workers in uncompetitive industries might keep their jobs a few years longer, world economic growth would be much slower, and world stock prices [i.e. our investments] would be correspondingly reduced in value.

On the other hand, investors will see some likely benefits from a Democratic victory in 2008. In terms of foreign policy, two of the three top Democrat candidates are likely to get the United States out of Iraq quickly, and to spend less overall on projecting U.S. power worldwide. This may, or may not, be a good strategy against global terrorism, but it would certainly save the cost of the Iraq war, currently about $170 billion per annum – equal to about 1.2% of GDP.

Since the Democrats also plan to reverse the Bush tax cuts, even if their healthcare plans prove unexpectedly expensive, they are unlikely to run much bigger budget deficits than the Republicans.

News and Related Story Links:

• Newsday:
  House OKs alternative minimum tax exemption increase.

• FoxNews.com:
  FOX News Poll: Clinton Retains Double-Digit Edge Over Obama Nationally.

• Wikipedia:
  Hilary Rodham Clinton.

• Wikipedia:
  John Edwards.

• Whitehouse.gov:
  Herbert Hoover.

• Wikipedia:
  Barack Obama.

• Whitehouse.gov:
  Harry S Truman.

• Wikipedia:
  Rudy Giuliani.

• Money Morning News Analysis:
  China’s Record Trade Surplus Again Inflames U.S. Criticism.

• Wikipedia:
  John McCain.

• Wikipedia:
  Ron Paul.

• Wikipedia: 
  Mitt Romney.

• Wikipedia:
  Fred Thompson.

• Wikipedia:
  Super Tuesday.

• Encyclopedia Americana:
  Warren G. Harding.

• Wikipedia:
  North American Free Trade Agreement.