No way to resolve the divisions in American society in the short term

On January 20 (US time), President Biden’s inauguration ceremony was held in Washington D.C. The chaos that many feared would take place in Washington and all around the country never occurred. With the effective political vacuum gone, and a peaceful transition of power achieved, US stock prices have been rising.

President Biden’s inauguration speech was consistent with what had been expected, containing no surprises. What he emphasized most in his speech was the reconciliation of American society. Biden made overtures to the supporters of former President Trump, calling for harmony and unity. Although Trump had also made a similar appeal for unity at his inauguration four years earlier, his subsequent rhetoric and conduct in fact inflamed divisions. Yet Biden, unlike his predecessor, will likely be steadfast in promoting reconciliation and unity in American society as a crucial policy issue.

However, all of the policies actually being set forth are directly opposed to those of the previous Trump administration, and will likely only instigate a greater conservative backlash and reinforce divisions. In fact, immediately after the inauguration, Biden signed an executive order returning the US to the Paris Accord from which the Trump administration had withdrawn. There is no way that the divisions running through American society will be resolved in the short term.

That said, since one of the factors driving these divisions is sluggish economic activity, the new Biden administration will likely concentrate its focus on economic policies for the time being. Janet Yellen, who was nominated for Treasury Secretary, indicated at her Congressional hearing that she would be looking to support aggressive public spending, while accepting that this would cause fiscal conditions to deteriorate further.

Will global divisions intensify with the US and China as the two dominant powers?

President Biden has stressed the need to improve relations with US allies which had suffered under the Trump administration’s “America First” policy. Achieving harmony domestic ally and abroad will be a pillar of this administration’s policy approach. Reconciliation with the country’s allies will likely not be as difficult as unifying American society, and progress will in fact be made going forward. On the other hand, the strengthening of alliances centered on the US will ultimately foment tensions with non-allies. Of particular importance is the fact that it will help facilitate the creation of the “China encirclement”. Secretary of State nominee Antony Blinken indicated at his Congressional hearing that he would be inclined to take a hardline stance toward China, particularly with regard to its human rights issues concerning Hong Kong and the Uighurs, for example. Yellen likewise suggested a tough stance against China on the issues of trade and currency.

Although US-China trade frictions are expected to lessen somewhat under the Biden administration, it does not seem likely that the conflict between the US and China will be eased. Given these circumstances, as is also represented in the current “vaccine diplomacy”, China will be scrambling to expand its roster of friendly countries, particularly among developing nations. While we will surely be seeing greater unity in alliances centered on the US, global divisions with the US and China as the two dominant powers will likely only intensify.

The “twin deficits” problem revived

Although the former Trump administration has left the stage, two negative legacies that it has left behind will no doubt continue to plague President Biden going forward. One of these involves the divisions in American and international society, as described earlier.

The second negative legacy is the “twin deficits” problem, which includes the deterioration of US fiscal conditions and moreover that of the country’s current account balance.

The large-scale tax cuts enacted by the Trump administration in 2017—i.e., the so-called “Trump tax cuts”—along with the increase in government expenditures (especially on military spending) created a serious distortion in the US economy. Specifically, that means the expansion of the “twin deficits”. This problem, which first attracted notice in the 1980s, has now been reignited.

The country’s federal fiscal deficit in FY2020 reached a record high $3.1 trillion, equal to around 15% of GDP and approaching the 20% level seen during World War II. In his initial budget in 2017, President Trump stated that accelerated economic growth would restore balance to the country’s finances, and thereby shrink the federal debt. Yet in actuality, even during a prolonged period of economic growth the fiscal deficit continued to grow, with the government’s debt only rising as a proportion of GDP. With the addition of Covid-19 countermeasures starting in 2020, the country’s fiscal environment has worsened even further.

As was apparent with the historically low unemployment rate which lasted until last spring, the implementation of expansionary fiscal measures while the US economy is faced with supply constraints causes imports to soar—so as to meet the growth in domestic demand which domestic output cannot match—and thus expands the trade deficit. The trade deficit figure grew from $481 billion in 2016 to as high as $577 billion in 2019.

The fiscal environment is set to deteriorate even further under the Biden administration

The expansion of the twin deficits will erode confidence in US fiscal management and in the dollar, and in financial markets, there are concerns that it is steadily heightening the potential risks of an unfavorable rise in interest rates and dollar depreciation. This raises extremely serious worries about the prospects for the world economy.

Furthermore, under the Biden administration with its proposed aggressive fiscal policies, the fiscal deficit is poised to grow even larger. According to estimates by the Committee for a Responsible Federal Budget (CRFB), a nonpartisan NPO, if President Biden moves to enact the economic policies that he touted in his campaign promises, the total hit to the federal fiscal balance will be approximately $5.6 trillion over the ten-year period from 2021 to 2030. President Biden pledged during the campaign that his policies would bring the corporate tax rate back up to 28%, reversing the Trump tax cuts which had lowered the rate from 35% to 21%, and would also raise the maximum federal income tax rate from 37% to 39.6%. Even with these actions, the impact from increased spending is expected to outstrip the effects of the tax hikes, meaning that the country’s fiscal environment is set to deteriorate even further.

The negative legacies of the former Trump administration

Under the Reagan administration during the 1980s, the expansion of the twin deficits brought about an increase in long-term interest rates and sent stock prices plummeting, and even intensified fears that the dollar would collapse. In response to the alarms being sounded in the markets, the government ended up making serious efforts toward fiscal reconstruction.

Within the Biden administration, tackling the twin deficits problem is low on the list of priorities. However, if the market’s warning bells should go off in a way that sends the financial markets into real chaos, that would probably deal a serious blow to the global economy as well. Before things reach that stage, President Biden needs to embark on fiscal reconstruction in earnest and tackle the twin deficits problem inherited from the Trump administration. That task could even be regarded as a responsibility owed by the US to the international community. Still, achieving this would seem to be quite a tall order.

At present, we find ourselves in the third dollar appreciation phase since the US switched to a floating exchange rate system in 1973. Chance disruptions of the US financial markets that see a decline in the dollar’s credibility, a reverse course toward dollar depreciation, and rising interest rates have the potential to damage the world economy.

It was fortunate that under the Trump administration, with its favoring of dollar depreciation, the twin deficits problem did not spur a major weakening of the dollar. Yet that only meant the problem was postponed for the Biden administration to confront.

The potential instability in the US financial markets rooted in this twin deficits problem thus constitutes a negative legacy of the Trump administration, not simply for Biden’s new administration, but for the world as well.

• Takahide Kiuchi
  

  Executive Economist