THE BLOG
12/11/2012 06:20 pm ET Updated Feb 03, 2013

Are the Krugman Fiscal Cliff Acolytes All Becoming Bond Traders?

We know politics sometimes makes strange bedfellows. But the emerging alliance between the most liberal wing of the Democratic Party led by New York Times columnist Paul Krugman (and lately David Korn, the "47 percent video" man of Mother Jones) and today's Wall Street heirs of The Bonfire of the Vanities' Sherman McCoy would make a fair number of evangelicals blush.

Krugman and Korn have been pushing the line that President Obama not only should settle for nothing less than total victory in his fight to allow the Bush tax cuts for the wealthiest Americans expire on New Year's Eve -- even if the Republicans don't budge and we go over the fiscal cliff -- but that he actually is likely to do so. The result: an immediate tax increase on all income levels and severe across-the-board cuts in military and discretionary spending that would compromise both national security and the social safety net -- would in their belief be short-lived (and seen by the financial markets as temporary) because the new Congress, still with Republicans in charge of the House but with a diminished majority, would quickly cave-in and give back the Bush tax cuts to Obama's "98 percenters" since their votes would no longer violate the Norquist anti-tax pledge.

Essentially, Krugman, Korn and other progressives argue that it is time for Obama to definitively assert that he was elected president and that Norquist wasn't elected to anything, and that John Boehner is speaker of the House, not of the United States -- second in line to the presidency, but not some sort of co-president.

There is clearly substantial merit in this analysis. Presidents can't bluff, and to quote the great political analyst Bob Dylan, even the speaker "can't win with a losing hand." The president during his first term tried to anticipate and incorporate established Republican ideas in his stimulus and healthcare legislation, and all it got him was the Tea Party, so a strategic change was surely in order after his decisive, four million vote election victory (bigger than Bush's in 2004, when the Wall Street Journal intoned that he had won an historic mandate).

Krugman and Korn assert (with some polling evidence to back them up) that Boehner and the Republicans, and not Obama, would bear the blame for going over the cliff). But polls, as we learned just last month, can be distorted by one's own rose-colored glasses. And there is usually a lot of blame to go around when the stock market crashes.

But K & K also dismiss the risks to the president -- and the economy -- from any stock market crash as it did in 2008 when Congress initially failed to pass the TARP legislation intended to prevent the worst case scenario from the "financial cliff' of a global credit collapse, and as it did in 2010 when the debt ceiling issue was taken to the brink and the U.S. lost its AAA credit rating precisely due to political gridlock.

They apparently believe that either a) the equity market -- even faced with arithmetic certainty of recession if we do fall off the cliff and stay there -- will not react as before because it trusts the GOP will cave, or b) even a stock market crash is better than a compromise where Obama "sells out" his base on taxes and entitlements.

Krugman and Korn may not realize, despite their deep knowledge of economics and the political blogosphere, that quite a few middle-class Americans care about their 401(k)s and their mutual funds' performance. Neither of these gentlemen has a conspicuous record as a market analyst or a stock-picker. And given their own started views that the Republican/Tea Party caucus is fundamentally irrational, why on earth would Krugman and Korn expect them to cave in January over a recession they believe (along with Rush Limbaugh) can and will be blamed on the president, and that they have always been willing to risk as far back as the debt ceiling debacle when they almost brought one on? And why would they believe the stock market would believe that, either?

The inevitable "cliff hanger" market crash is not a "bump in the road" -- to borrow a better metaphor from the President himself, it's more like driving the car into yet another ditch, and a muddy ditch at that.

The only winners when the equity market crashes are usually the bond traders who are long in their market just as the panic "flight to safety" in U.S. Treasury securities begins. Then Krugman and Korn are really on Sherman McCoy's turf. He made millions out of nickels -- billions of nickels. And even with bond prices at historical lows thanks to the Federal Reserve, you can bet the house on a rocket of a rally in bond prices if we go over the cliff with a stock market crash at year-end.

On that level, it seems only fair to conclude that the sole rational basis for the Krugman and Korn view of what the president ought to do is that they have applied for positions in the entering fixed-income training class at Goldman Sachs.

This not to say that the Republicans aren't being even more hard-headed than they accuse Obama of being -- their latest proposals calls for giving the top two percent an even bigger tax cut than Bush provided, and they have been totally unspecific as to which deductions that would cut back -- mortgage deductions, charitable deductions, state and local taxes, medical expenses, education costs, unreimbursed business expenses? (Take that, small business!) Brinksmanship is a two-way street on a one-lane road.

The view here is not that Obama should cave -- just that he should not take the view that a deal doesn't really matter to real people who don't enjoy the luxury of Krugman and Korn's employment. Business will remotely begin to hire in a political wasteland after market crash: on the contrary, it will fire and fire again, because even more than politicians, business is into surviving.

Obama must take pains to expose the Tea Party and the Limbaughs and the Norquists as the ones who don't care about a recession or a stock market crash. They are the real Sherman McCoys. They will trade a crash for what its worth to their cause. He should make them an offer, soon, that keeps his principles but is apparently one they can't refuse, precisely because it is in their nature to do just that -- refuse, right in front of the American people. The market will wobble; but then, and only then, can cooler heads prevail. All this should happen well before Christmas, however, not after all hell breaks loose on January 1. Hell hath no fury like a stock market scorned.