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Economic Affairs: The coming Biden boom

The Biggest Spending Spree In A Generation Could Be Transformational For The US And The Global Economy, But With Some Possible Nasty Side Effects


Less than a month after the US Congress passed the US$1.9 trillion (S$2.6 trillion) American Rescue Plan, President Joe Biden has announced a US$2 trillion to US$2.5 trillion infrastructure package, soon to be followed this month by a social spending plan of as yet unknown proportions, but likely to be of the order of another US$1 trillion at least.

So, with upwards of US$5 trillion in spending - more than 20 per cent of gross domestic product (GDP) - being tabled within three months of the start of the Biden presidency, Bidenomics has begun with a bang.

The result of this biggest spending spree in a generation could be transformational, both for the United States and the global economy. It's all far from a done deal. There will be political hitches along the way, and possibly some nasty economic side effects afterwards, some of which will also be felt in Asia.

But in the short term - at least through next year - a robust case can be made that the US economy is headed for its biggest economic boom since the 1980s.

Most economists, including at the US Federal Reserve, are pitching GDP growth forecasts north of 6 per cent for this year. Some, such as Moody's Analytics, even project 8 per cent.

Pent-up demand

These outsized prognoses are plausible. The US economy will be emerging from the recessionary year of 2020, during which its GDP contracted 3.5 per cent, which means its expansion this year will be from a relatively low base.

There is a huge amount of pent-up demand about to be unleashed as Covid-19 comes under control and consumers go out and spend.

The US savings rate has shot up to 13 per cent of disposable income currently, almost double the long-term average of 6.5 per cent - partly on account of limited spending opportunities during the pandemic - which means there is at least US$1 trillion sitting in bank accounts that will find its way into the economy as it opens up.

On top of that, under the American Rescue Plan, most Americans will get a third round of stimulus cheques amounting to US$1,400 each (double that for couples) plus US$1,400 for each dependent.

So the average family of four would get a windfall of US$5,600. They will also get thousands of dollars in childcare credits and the jobless will receive enhanced unemployment benefits till Sept 6.

With all this largesse compressed into a few months, with more to come, the stage is set for a demand-led boom that will turbocharge the economy and maybe also prices of some assets such as stocks, real estate and crypto-assets.

An infrastructure boom

Then there will be the infrastructure spending, which will create jobs at scale. The US unemployment rate has already fallen to 6 per cent from 14.7 per cent last April. Next year, if not earlier, the economy will be back to full employment.

Spread over eight years, infrastructure spending - on highways, bridges, mass transit, broadband Internet, the power grid and more - will also boost the economy's productive capacity and raise productivity.

But this is a "blue skies" scenario and a lot needs to happen before it can materialise. Whereas the American Rescue Plan - basically a Covid-19 relief package - is relatively uncontroversial, the same cannot be said for the infrastructure spending binge which, at this stage, is no more than an ambitious 26-page fact sheet.

In a country where rural and urban voters are largely divided along political lines - rural voters tend to be more Republican and urban voters more Democrat - the question of what infrastructure should be a priority becomes contentious.

Republicans are in favour of highways that connect rural communities as well as projects to help farmers, but have less interest in items such as urban transportation, low-cost public housing and green energy, which are mostly favoured by Democratic constituencies.

On their part, progressive Democrats feel that the spending proposals don't go far enough, especially when it comes to tackling climate change.

For example, Democratic Representative Alexandria Ocasio-Cortez - a leading figure among progressives - has called for a US$10 trillion infrastructure package, about four times as large as what has been proposed.

Corporate interests will also weigh in to pitch their favoured projects and there are already arguments about which "economically important" bridges need to be upgraded. The infrastructure plan has become a political football, with opposition from Republicans especially, but also some Democrats.

Pushback on taxes

Even more contentious is how the plan will be financed. Whereas the American Rescue Plan is being funded entirely by government borrowing, Mr Biden wants to finance the infrastructure plan through higher corporate taxes.

In 2017, the Trump administration had slashed the corporate tax rate from 35 per cent to 21 per cent. Mr Biden has proposed partially reversing these cuts by raising the tax rate to 28 per cent. On top of that, he wants to penalise offshoring of business activities - including by scrapping the tax exemption on the first 10 per cent of profits generated from international operations - encourage reshoring through tax credits and impose a global minimum tax of 21 per cent, which will force companies to pay US tax regardless of where they book their profits, which many do in low-tax jurisdictions.

Mr Biden proposes that the social spending plan - which has yet to be spelt out - would be funded largely by increases in personal tax rates on those earning more than US$400,000 a year.

These tax proposals have already run into a wall of opposition from Republicans and business interests. Republicans say corporate tax hikes are a non-starter, while business lobbies have denounced them as archaic and misguided, pointing out that they would handicap US companies vis-a-vis foreign competitors and act as barriers to job creation and economic growth.

Mr Biden has indicated that he is open to alternative proposals to fund the spending programmes, provided they do not raise taxes on people earning less than US$400,000. In the negotiations that follow, the tax proposals will be fiercely contested. And while the Biden administration would expect this from Republicans, it would not want to alienate business groups or the progressive wing of the Democratic Party.

And so, the spending and funding proposals will be the subject of much lobbying and haggling among vested interests that could go on for months.

In the end, the final legislation - which the Democrats hope the House of Representatives will pass by July 4 - will probably be quite different from what is proposed.

In particular, the chances are that while most of the spending measures will go through or even be enhanced, the tax measures will be watered down, which means more of the spending will have to be funded by government borrowing, monetised by the Fed.

Inflation risks

This would heighten the risks of inflation in the future.

With the unemployment rate still slightly elevated and a fair amount of underused capacity in the economy, this is not an imminent threat.

But by next year, the situation could change. There are already some early warning signs.

US 10-year bond yields, which are sensitive to inflation pressures, have risen past 1.7 per cent, the highest level in a year.

Proxy measures of inflationary expectations are running at their highest level in a decade and some commodity prices are soaring, adding to costs.

Even the Fed now sees inflation running at 2.4 per cent this year, up from its estimate last December of 1.8 per cent, and above its 2 per cent target.

The surge in spending spurred by the Biden stimulus will add to price pressures. While the infrastructure boom will also add to capacity and supply, it will run behind the surge in demand.

The moment of truth will come some time next year, when the economy is operating at close to full capacity and the spending spree - supposed to be spread over eight years - will still be in its early stages. At that point, price pressures will become more intense.

Although the Fed is currently dismissing concerns about inflation and has pledged to keep interest rates at close to zero until 2023, it could quickly change its tune - as it did when it flip-flopped from three years of tightening monetary policy to loosening in July 2019, and then rushing to near-zero interest rates last year.

When the situation on the ground changes, the Fed adapts - no matter what it might have signalled earlier. Interest rate hikes next year - which cannot be ruled out - would moderate the economic expansion and hit financial markets hard.

Benefits and downsides for Asia

At first, Asian economies, and especially its major exporters, will benefit from the booming US economy, which will suck in imports at a faster rate.

But the benefits will not be as much as would be expected under an environment in which multilateral trade is functioning normally.

One of the downsides of the Biden stimulus for other countries is that it will be accompanied by aggressive "Buy American" policies on government procurement - Mr Biden has stated this categorically - which will account for much of the spending. This would be discriminatory and almost certainly illegal under World Trade Organisation (WTO) rules.

But if any complaints to the WTO are lodged, they will go nowhere if the US appeals, given that WTO's appellate body, which currently has no judges, is dysfunctional.

So far, the Biden administration has shown no inclination to appoint new judges.

If the tax provisions that discourage offshoring and encourage reshoring go through, US direct investment to Asia (and elsewhere) would also be lower than otherwise.

And if higher inflation next year prompts the Fed to hike interest rates earlier than expected, that would not only temper the US economic boom and create financial market turmoil, but also lead to a stronger US dollar, which could be painful for emerging economies with high dollar-denominated debts.

It could also force these economies to raise their interest rates, which would threaten their economic recoveries.

On balance, the Biden boom would still be a welcome shot in the arm for Asia and the global economy, but some of its second-round side effects could be painful.