Hamish McRae: A poisoned chalice for a new president, but the Democrat could still make a difference

Just for fun, let's assume John Kerry wins in November. What will he inherit, how will he cope with it, and what might it mean for us?

Just for fun, let's assume John Kerry wins in November. What will he inherit, how will he cope with it, and what might it mean for us?

Huge economic imponderables lie between now and the end of the year. Chief among these is the state of the oil market (see below), the weakness of the dollar and the economic performance of China. But there can be little doubt about one thing - the extent to which demand has been pumped up by the US consumer. That in turn has been associated with the widening of the twin US deficits, the fiscal one and the current account one, both of which are now close to 5 per cent of GDP.

Consumption has been boosted by cheap money and tax cuts. The former is now coming to an end as the Federal Reserve heads into the tightening phase of the cycle, bringing interest rates back to more normal levels. Expect another rise in rates when the Fed Open Market Committee meets on 21 September. As for the latter, I had not fully appreciated how big an impact the tax cuts have had on family budgets until I saw the left-hand graph above. As you can see, personal taxation has fallen from a peak of 15 per cent of family income to less than 11 per cent. The total Federal tax take (most states levy taxes on top) has fallen to 16.5 per cent of GDP, the lowest since Dwight Eisenhower was President. Money not spent on taxes is money available to spend in the shops.

Americans, like Britons, have borrowed against the rising value of their homes. But equity take-out is now expected to fall, maybe reverse - as the right-hand graph showing some forecasts from HSBC suggests. This need not mean that consumption will actually fall, just that it will grow more slowly, but it is clear that President Kerry is likely to inherit a much cooler consumption climate. What will he do?

What he promises is fiscal discipline and a return to Clinton-style, revenue-neutral policies. Cuts in taxes would only take place if spending were cut too. He also has a fiscally conservative voting record in the Senate. But as President, he may not do what he says, for the detail of his proposals now suggests a deficit much the same as that in the plans of President George Bush. Mr Kerry would repeal the Bush tax cuts on homes with an income of more than $200,000 but would keep the rest - assuming that he could get this through Congress. But while both men promise higher spending on healthcare, Mr Kerry's plans would cost much more. Indeed, these proposals alone, were they to get through Congress, would more than offset any revenue retained by his proposals on income tax. They probably would not get through Congress, though; the President proposes, Congress disposes.

So on the plans so far, and allowing for these to be modified by Congress,not much is different. An element of make-believe also pervades the two sets of plans. Both candidates are saying they would halve the federal deficit over the next four years and both are relying on a strong economy, generating strong growth in tax revenues, to do so. If the argument above is right and the US consumption boom draws to an end, growth will be slower and revenues lower. Accordingly, the deficit will not narrow and may even grow.

If this happens, the game changes. You cannot predict either the timing or the events that will trigger change. The obvious candidate would be a run on the dollar, but I don't think it needs to be that. The trigger could be internal: a political concern about the federal debts being run up that will have to be serviced somehow by the next generation of taxpayers. Progress may not be possible - or demanded - unless and until Congress is dominated by Democrats. But the chances are that over the next four years a start will be made on the path back to greater fiscal responsibility, and President Kerry - we are still assuming he wins - will somehow have to manage the country along that path.

So the issue that matters is not the Kerry plan but the Kerry performance. Can he manage Congress? What is the composition of Congress? What is the quality of his Treasury team? Will it be enough to be orderly, competent and dull? Could it be that this will turn out to be the election - not the previous one - that you would want to lose?

The bottom line, as Americans would say, is that in economic terms this will be a difficult presidency - more difficult in all probability than the present one. It will be more difficult because problems that are normally sorted out during the down-swing of the economic cycle have not been adequately tackled this time. That is not particularly the fault of Mr Bush, for an over-loose monetary policy is as much to blame as an over-loose fiscal one.

That will have considerable implications for the rest of the world, including the UK. Global demand will be weaker than it is now, so maintaining growth here will depend on our own efforts. We will be helped marginally by more expensive oil, for the UK will remain a net exporter for a little longer. And we will be helped by the freedom the Bank of England has to cut rates if domestic demand slows, as it seems to be doing right now.

But how the US tackles fiscal policy is not just a matter of macro-economic aggregates. The influence of President Kerry will go beyond the boundaries of the US in one further area. What the US does to its tax system sets standards for the rest of the world. Will Mr Kerry at last start to reform US social security - for example, by allowing people to pay part of their retirement pot into a private investment account?

And what about changes in the US system of having an alternative minimum tax - a parallel income tax that makes sure rich Americans, who are adept at cutting their tax bills, pay a basic minimum? It is not indexed and so is catching more and more people.

We know little about John Kerry's views on these long-term matters, for he has said little and you cannot glean much from looking at his voting record. But tax reforms in the US matter for us too. A sensible US President could start again setting some global benchmarks for taxation. And maybe, maybe, John Kerry will be a sensible President.

Oil supplies feel the trickle-down effect

Is the car's petrol tank half full or half empty? We are all worrying about the price of fuel, and not just for the obvious reason of the sharp pain in the wallet when filling up.

What seems to be the only safe assumption is that fuel will remain expensive for the foreseeable future. Here in Britain, we are to some extent protected by the strength of sterling. In dollar terms, the crude oil price has risen past the peak it reached during the first Gulf War, but in sterling terms it is still a touch cheaper. And in real terms - that is, adjusted for the decline in the value of money - we are only about half the level of the late 1970s peak.

That is the half-full perspective. The half-empty one is the growing awareness that the underlying supply-demand balance is less favourable than it was during previous oil price peaks. In the two 1970s oil shocks, the price was pushed up by Opec restricting supply. In the early 1990s it was the war. But now Opec seems to be pumping as much as it can, and demand, thanks in part to Chinese growth, keeps rising.

Opec's output in July seems to have been slightly down from the June level, mainly because of a decline in output from Saudi Arabia. It is not clear why this has happened, as the Saudis have pledged to increase supply rather than cut back. But it has given rise to new concerns that the country is struggling to increase output for technical reasons, mostly to do with the giant Ghawar field, the largest in the world. Incidentally, the world's second-largest field, the Cantarell in Mexico, is now producing less than it was a couple of years ago and may be starting its own decline.

Without being too alarmist about all this, oil experts are beginning to worry that global oil production may be starting to approach its peak, for all the newly discovered fields around the world are much smaller than these giants. The only safe assumption is that the global oil supply will remain extremely tight from now on - and tight for technical reasons, not for political ones.

Most of the price of fuel in the tank is tax, of course, so it would be perfectly possible for governments to offset the rise in the price of crude by cutting tax. Somehow, though, I don't think this is going to happen.