Countdown to the Election: Government Gridlock

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Before the email scandal
Prior to the current election and the scandalous revelations that seem to occur almost daily, one of the biggest ongoing US political stories the past few years has been gridlock. Historically, gridlock can be loosely defined as when the executive branch is controlled by one party and the legislative branch is controlled by another party, providing checks and balances that often thwart bills from becoming laws.

Government gridlock can be both a positive and a negative, although a lot of it depends on perspective. As former Senate Majority Leader Bob Dole put it simply several decades ago, "If you're against something, you'd better hope there's a little gridlock." In short, if one believes that 'a government that governs least, governs best,' then gridlock is a positive.

President James Madison is arguably the founding father of government gridlock. Well before he became president, Madison was an author and proponent of the US Constitution. In Federalist Paper #51, Madison advocated for checks and balances and the gridlock it can create. The three-branch structure of the government ensured that each branch would keep the others "in their proper places." Madison believed there would always be people and groups that sought to further their respective agendas. However, the Constitution would ensure that "ambition would counteract ambition."

Over time, government gridlock has generally been viewed positively by the stock market, as the less that gets accomplished, the less regulation and the less government spending result. However, that conventional wisdom has become challenged in recent years because government gridlock—which has always ebbed and flowed over time—has gotten much worse, suggesting a high level of dysfunction among the country's leaders.

Origins of the current crisis
The current gridlock crisis began in 2011; Republicans had won a majority in Congress the previous year, helped by the popularity of the anti-government spending, anti-tax Tea Party movement. Congressional Republicans focused on lowering the deficit, insisting that President Obama reduce government spending in order to win support for an increase in the debt ceiling. The stakes were high: if the US exceeded its debt ceiling, the Treasury would be forced to either default on its payments to its bondholders or stop payments to those it owed money to, including its employees, vendors and recipients of government benefits.

No one wants extreme gridlock as the country is dependent on having a government that can manage its public affairs which includes paying its bills and keeping the economy operating. Yet recent history also shows that one-party control of government creates the potential for a misguided appetite for aggressive programs that might go too far. Instead, the Goldilocks approach, with power evenly divided and well-meaning leadership, produces enough just enough tension for government to get things done, albeit not in a very inspirational way.

Not surprisingly, extreme gridlock is viewed negatively by the stock market. The latest gridlock crisis resulted in the most volatile week for financial markets since 2008. Either option—government shutdown or surpassing the debt ceiling—would have led to a full-scale crisis, which was averted when legislators agreed to substantial spending cuts in the future.

However, the dysfunction and near-disaster resulted in Standard & Poor's downgrading US debt for the first time in history: "the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges." Since then, Congress has illustrated on multiple occasions that it is incapable of reaching a compromise—the most glaring of which was the spending bill that resulted in the government shutdown of 2013. However, this ended badly and Congress vowed that it would not happen again, and indeed it hasn't.

Girding for more gridlock
Yet there is another side to gridlock—it not only blocks bad ideas from being enacted, it also can facilitate meaningful discussion when everyone's back is against the wall. This might sound peculiar until you realize that public policy debates require compromise, and this usually occurs when the political centers of both political parties agree to something that they both can live with.

Given the fact that the political parties have become increasingly ideological, this occurs less frequently as individual legislators and both parties decide that the politically safe option is to dig in and not anger one's rigid political base. However, when there has been a need for action in recent years because of the threat of a government shutdown, expiration of tax cuts or a default on government debt, the executive and legislative branches have been able to reach agreement and have even periodically produced good public policy.

This presidential election has the potential to result in greater government gridlock, but it also has the potential to reshape the two major political parties in the US. Donald Trump has not been able to win the support of some moderate Republicans; it remains to be seen whether he would be able to work effectively with them, let alone Democrats, if he were elected president. Similarly, Hillary Clinton has had difficulty winning support from the left wing of the Democratic Party. If she pursues a more centrist agenda, she may meet opposition from this faction.

In short, this election could result in a greater fracturing of the two major political parties in the US and perhaps a reshuffling of alliances across party lines. A little more than a week from now, after a long and loud campaign, the American electorate will determine the composition of the executive and legislative branches of its government. And if current trends continue, the divisiveness of the election looks to translate to even more government gridlock over the next presidential term.

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About the Authors
Kristina Hooper is the US investment strategist and Head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law, a master's degree from Cornell University and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Peter Lefkin is the senior vice president of governmental and external affairs with Allianz of America Corporation, which he joined in 1988. He leads the firm’s state and federal lobbying efforts in the US. Mr. Lefkin has a B.S.F.S, cum laude, from the Georgetown University School of Foreign Service, and a master’s in public administration and a J.D. from Syracuse University.

Important Information
This material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.

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