Author: Gary Clyde Hufbauer, PIIE
The forces inherited from 2022 will shape the U.S. economy in 2023. High but falling inflation, rising interest rates, neo-protectionist industrial policies, a standoff with China, empty trade ideas and the return of former US President Donald Trump. From an Asian perspective, the macro impact of US economic policy was positive, the micro impact was negative, but the security guarantees were welcomed.
Political gridlock in Washington, with tight margins in the House and Senate, has cast a shadow over the economic situation. The extreme positions advocated by right-wing Republicans and left-wing Democrats have made it difficult to reach agreement on important legislation. Neither Democrats nor Republicans will advocate painful spending cuts or tax increases to rein in the high budget deficit, which currently stands at 6% to 7% of GDP. The United States is on a fiscally unsustainable path.
Annual inflation, as measured by the consumer price index, peaked at 9.1 percent in June 2022 and slowed to 3.2 percent in November 2023. Price inflation spiked in the first half of 2022 as a result of Russia's invasion of Ukraine. This has spurred wage inflation, and the Fed's biggest decision in 2024 will be how long to maintain monetary tightening to ensure inflation returns to the desired 2%.
Chairman Jerome Powell removed the word “temporary” from the Fed's inflation language in November 2021. He initiated a sustained increase in the federal funds rate, from zero in January 2022 to 5.25% to 5.5% in July 2023. Chairman Powell's goal was to achieve inflation. He will achieve his 2% inflation target even at the cost of increasing unemployment. Still, there was no slowdown in the U.S. economy in 2023.
Instead, Wall Street and Main Street enjoyed a “soft landing” scenario. When the inflation rate exceeded 2%, the theme for interest rates became “high interest rates for an extended period of time,'' and the 30-year US Treasury yield reached 5% in October 2023, and then fell. Keeping interest rates high is aimed at curbing inflation, but skeptics predict a mild recession in 2024.
In early 2023, multiple local banks went bankrupt due to large unrealized losses on their government bond portfolios due to rising interest rates. The Fed contained the crisis by acting as a lender of last resort, allowing distressed banks to borrow against the face value of their bonds. But many local banks are now grappling with distressed commercial real estate loans as office vacancies continue to grow due to the work-from-home trend caused by the coronavirus pandemic. This could lead to a new regional bank crisis in 2024.
Rising interest rates in the United States strengthened the dollar against most currencies throughout 2023. As a result, Asian countries paid more in local currency terms for U.S. exports, but at the same time earned more from exports to the United States. Additionally, sustained GDP growth in the United States attracted imports from Asia.
Although some Asian central banks raised interest rates, Asian stock markets did not fall significantly. From December 2022 to October 2023, Japanese stocks rose 18%, Korean stocks rose 10%, and Taiwanese stocks rose 16%, but Chinese, Singaporean, and Australian stocks ended the year almost flat. Towards the end of 2023, the dollar depreciated slightly due to expectations that US interest rates would fall in 2024.
US President Joe Biden declared Buy America a core policy in his State of the Union address in February 2023, without mentioning the cost of this policy to taxpayers or America's allies. In 2023, a new reality hits our Asian partners with the implementation of important multi-year industrial policies. The five-year, $1.2 trillion Bipartisan Infrastructure Act of 2021, which funds highways, bridges, railroads, high-speed internet, and electric vehicle charging stations, procures U.S. goods and services with every federal dollar. It was mandatory.
The US$278 billion Chip and Science Act of 2022 will provide US$78 billion in subsidies to the semiconductor industry over five years. Funding is equally available to foreign companies, and Samsung and Taiwan Semiconductor Manufacturing Company have been lured to build large-scale manufacturing plants in the United States. Europe and Japan are now forced to provide subsidies to stay in the semiconductor race.
The US$394 billion misnamed Inflation Reduction Act of 2022 added neo-protectionism to climate-friendly efforts. Subsidies for batteries and electric vehicles depend on production in the United States or a free trade agreement partner country. In response to complaints from Japan and South Korea, special workarounds were devised to accommodate export interests.
Slow-motion decoupling was a policy theme for 2023. US Treasury Secretary Janet Yellen and National Security Adviser Jake Sullivan tried to distinguish between risk aversion and decoupling, but to Chinese ears it was a play on words. Exports of advanced semiconductors, whether made in the United States or by allied Asian companies, are prohibited, and a number of Chinese companies have been placed on the U.S. Commerce Department's Entity List. The Biden-Xi summit in November 2023 focused on developing guidelines to avoid military conflict, but no commercial progress was made. Asian countries trade more with China than the United States, so they will try to push the envelope.
Despite the criminal charges and civil lawsuits, polls show Trump with a favorable position heading into the 2024 election. In addition to the devastating geopolitical implications of President Trump's second term, the strengthening of America First policies, starting with the 10% flat tariff, will be reminiscent of the disastrous Smoot-Hawley tariffs of the 1930s. .
Gary Clyde Hufbauer is a non-resident senior fellow at the Peterson Institute for International Economics.
This article is part of an EAF feature series looking back at 2023 and the year ahead.