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EM and the big Biden growth rotation
20 January 2021
In addition to bridging deep social divisions in American society, President Joe Biden faces two important policy challenges. One is to eradicate coronavirus. The other is to turn the economy – and voter sentiment – decisively in his favour in time for the mid-term election in November 2022. Otherwise the Democrats could lose their slim majority in the Senate and render the Biden Administration a lame duck less than two years after taking office.
To overcome this dual challenge, the Biden Administration is likely to expand the role of the state significantly over the coming years, particularly in the fiscal space. This marks a departure from the private sector-led growth strategy, aided by very easy monetary policies, that has prevailed since the 2008/2009 Global Financial Crisis (‘GFC’).
Three factors necessitate the shift from private to public sector-led growth. First, the private economy is now struggling due to real exchange rate overvaluation, low productivity growth, an excessively strong Dollar, heavy debts, and growing social problems. It will therefore not be able to provide the same lift as ten years ago. Second, monetary policy no longer has much to offer in terms of helping to lift growth rates. Third, the Biden Administration has neither sufficient time nor sufficient political capital to pursue a longer-term strategy of supply-side reform-led growth.
The rise in government spending over the next few years is likely to be the biggest since Roosevelt’s New Deal and will have profound implications for the investment environment. Debt levels will rise and productivity growth will decline. Constraints on the Fed’s ability to normalise monetary policy will intensify and the risk of financial repression will increase, particularly if inflation returns. The US real effective exchange rate will become even more overvalued due to declining productivity, yet risks to the Dollar increase at the same time. The Biden Administration may also introduce changes in taxation and anti-trust policies, which could weigh on equity markets in particular.
This report outlines these dynamics in greater detail and spells out their implications for EM and other investors.