Now the real test begins for Obama

Will President Barack Obama be a modern-day Franklin D Roosevelt, who pulled the US back up over the economic precipice, or will he be a disastrous copy of his predecessor, Herbert Hoover?

In the midst of these historically grim times, and with the US facing its worst financial crisis since the Great Depression, the question is a haunting one. The ebb and flow of presidential fortunes are often at one with the ebb and flow of the economy, and the 44th holder of the office will be defined by his handling of the present crisis – and probably very quickly.

A crumbling housing market has left millions of Americans facing foreclosure, income inequality is at its greatest in 80 years, and a credit squeeze has pushed homes, student loans and even cars out of the reach of many families. It was all quietly adding up to an economic crisis, even before the bottom fell out of the financial markets in September, laying waste to people’s retirement savings and threatening a surge in unemployment that will be apparent in figures out as soon as tomorrow.

Meanwhile, the Durst Organisation had to squeeze a “1” on the front of its national debt clock, as it ticked over $10 trillion last month – a stark symbol of what economists have been warning for years, namely that the US has mortgaged its future to overseas lenders who could pull their money out at the slightest whiff of a budget crisis, or simply if they come up with a better idea for their investing their money (say, for instance, China’s own growing economy).

And as if these are not concerns enough, the international community is demanding that the US and its new leader do more than get its own house in order. Jose Barosso, president of the European Commission, laced his congratulations yesterday with a call for the US to lead “a new deal for a new world” that will repair the broken global financial system. Business leaders, including Rupert Murdoch, warned that Mr Obama should not retreat into the protectionism that defined parts of his campaign.

President Obama will balance precariously atop an economic see-saw. On one side, there is an urgency to use government money to ease the financial hardship and to reflate the economy. There may be taxes foregone, perhaps even a reversal of the campaign pledge to raise taxes on capital gains for the investing class. There will certainly be new spending on job-creating public works projects, an idea that has long appealed to Mr Obama and his economic advisers from the University of Chicago. No one is advocating Hooverish austerity now. The question is how far one can safely move.

On the other side of the see-saw, Mr Obama’s room for manoeuvre is crimped by the budget deficit, already expanded twice in the past few months to reflect the nationalisations of mort

gage giants Fannie Mae and Freddie Mac and the signing of the $700bn banking bail-out package. In some ways it reflects the battle early on inside the Clinton administration between those who favoured public works to accelerate the economy out of the last Bush recession, and those – ultimately victorious – deficit hawks, who thought the first priority should be paying down debt. Then, they had at their side Alan Greenspan, veteran chairman of the Federal Reserve, who preached fiscal rectitude to the novice president. Today, after Mr Greenspan declared himself “shocked” to discover the credit crisis had revealed a “flaw” in his laissez-faire world view, the hawks are back in the coop. Mr Greenspan’s more doveish successor at the Fed, Ben Bernanke, has given a green light for a large economic stimulus package.

A green light, yes, but he has not dismantled the traffic lights. Faced with much lower than expected tax receipts because of the recession, President Obama could find that longer-term spending priorities – from subsidies for alternative energy, through universal healthcare to social security reform – have to be postponed. It may be that, faced with a heavily Democratic House and Senate, newly energised, the new president’s biggest challenge will be dissuading them from pushing the ambitious agenda he espoused on the campaign trail. The markets, for certain, will be urging him to rein in a tax-and-spend liberal Congress – and for the markets, one should read those foreign investors that have bankrolled the US deficit.

President George Bush will begin redesigning the international financial architecture with a summit of 20 leading nations as early as next weekend, even as the world looks to Mr Obama for his new economic team and a leadership role. Even then, it will be difficult to translate highfaluting talk of a new Bretton Woods into real results. The Democrat will for sure be much more attuned to international regulatory co-operation than his predecessor, should some new ideas emerge, but the reality is that his focus, when it comes to preventing a repeat of the credit crisis, will be on shaking up and strengthening domestic regulation.

All of which is for the longer term. If the new president even has the luxury of thinking medium-term, that will be an improvement on the current situation, where the federal government is being buffeted by short-term crises in the financial markets and oftentimes being forced to sign up to radical policies that they were dismissing just days previously.

As a result of these emergency measures, the new president will inherit a banking and mortgage system that is in large measure under federal government control, a situation with which a Democrat is likely to be more comfortable. Mr Obama will be more inclined to use the new levers available to ease the worst of the downturn for ordinary Americans. Mortgages can be renegotiated, foreclosures forestalled and new home loans showered about to help stimulate the housing market – but all of this comes with political pitfalls and the potential for longer-term damage by suppressing economic innovation. If the economy recovers, the question of how and when to re-privatise these institutions will move swiftly up the agenda.

Despite the rhetoric on the campaign, few expect Mr Obama to much challenge the economic orthodoxy of free trade, even though his union supporters are banking on a renegotiation of the North American free trade agreement that they blame for shipping jobs overseas. Austan Golsbee, his chief economic adviser, privately told Canadian embassy staff not to worry, as we learnt from an embarrassing memo leaked during the primaries, and the free flow of capital is more important than ever to a nation in hoc to foreign investors. But only the name of a new Treasury secretary will truly reassure, and pressure for protectionist measures could grow in the country if unemployment does not subside.

For now, though, the new president looks set to turn on the spending taps and hope against hope that this is enough to re-liquify the economy. And his time starts now. He could put his stamp on the issue before his inauguration in January by guiding the efforts of a lame-duck session of Congress that resumes after the election and which has already begun debating a stimulus package. Its contours – and therefore the outlines of Obamanomics – could begin to take shape within days.