The U.S. Economy Is Melting Down in June 2022

For a variety of reasons, the rapid meltdown of the U.S. economy we are now experiencing will likely be far worse than anything experienced in living memory. The closest example in recent decades is the stagflation during President Jimmy Carter’s single term (1977-1981) up to the middle of President Ronald Reagan’s first term (1981-1985). During Carter’s 1976 presidential campaign, he popularized Arther Okun’s misery index to criticize his opponent, the incumbent President Gerald Ford. The misery index is the sum of the U3 unemployment rate with the M2 inflation rate. At the end of Ford’s administration, it was at a relatively high value of 12.7 %. By the end of Carter’s single administration in December 1980, the misery index stood at an even higher level of 19.55 %. It was because of this high misery index that Carter was a one-term president.

There are many more economic indices of greater importance in explaining the country’s economic performance. However, the misery index is of paramount importance in displaying the political impact of economic developments. We shall have to keep it in mind.

What the Economic Statistics Tell Us

By now, the inflation trend you see in the theme image above should be no news to you. All the news media and the Biden Administration itself recognize high and accelerating inflation as a severe threat to the economy. However, there seems to be a great deal of confusion (at least among Democrats) about what the main causes are. The Biden Administration is blaming a great many things for its cause: the Russian invasion of Ukraine, the Covid-19 pandemic, price gouging by corporations, and the Republicans for blocking his plans to bring down inflation. Biden and his Democratic supporters blame everything other than their own policies. Although some inflation can be blamed on the Ukraine invasion and on the pandemic, Biden’s policies are of much greater importance. More on this in the penultimate section below on the Biden Administration’s responsibility.

By itself, inflation is indeed a severe threat. It disrupts the economic signals sent by prices as to what should be produced and how much. Also, it reduces the capability of companies and people to demand economic goods and services. Money is no longer a store of wealth as its value erodes.

However, inflation is also a symptom of many things going wrong for the economy. This can be seen in the equation for the inflation rate below. Let the value of the Consumer Price Index (CPI) be denoted by P, the M2 money supply be denoted by M, the velocity of M2 money (the average number of times an M2 dollar changes hands in a year) be represented by V, and the nation’s GDP in some base year’s constant dollars be denoted by y. Then the relationship between these variables is given by

MV is the total dollar value of all transactions in the current year in current dollars. The price index is then the annualized GDP in current dollars compared to the GDP in constant dollars.

Let the annual change in the price index be given by ∆P, with similar expressions for the other variables. Then, the annual inflation rate can be derived as shown below. [NB: You can find a derivation of this equation in a PDF found here.]

By definition, the inflation rate is the percent change in the price index. What this equation tells us is that inflation increases with the percent increase in the money supply and in the velocity of money, and decreases with the percent increase of the GDP. Each of these terms can switch sign, in which case they go from inflationary to deflationary.

You no doubt have heard the old saw that “inflation is too many dollars chasing too few goods.” That saying summarizes the effects of the first and last terms of the equation. However, there is the additional term that is the percent change in the velocity of money. This quantity depends very sensitively on the inflation expectations of the population. If the inflation is not yet hyperinflation (say, accelerating inflation that is greater than 10 %), people will curb their economic demand, holding their currency for their most important needs and hoping for a return to a noninflationary environment. The velocity of money might actually decline slightly in such an environment. However, as the economy transitions into a hyperinflationary environment. people will see the value of their money evaporate before their very eyes. They would then want to get rid of their money as soon as they possibly could before its value disappears altogether. This is the history of hyperinflation in Weimar Germany between 1921 and 1923. The price of a loaf of bread in Berlin went from 160 Marks at the end of 1922 to 200 billion Marks in late 1923.

So, what do economic statistics tell us about the changes in the three aggregate quantities that determine the inflation rate? Let’s first take a look at the amount of money chasing all the goods.

The blue solid line is the M2 money stock while the dashed red curve is its percent change from a year earlier. The pink shaded rectangle is the period of recession created by state economic shutdowns in response to the Covid-19 pandemic. Government programs in reaction to the pandemic were financed by deficit spending. To finance this deficit spending by selling bonds, the Federal Reserve rapidly increased the money supply. At its peak in February 2021, the money supply was growing at a year-over-year value of 26.9 %. Since then the growth rate has declined greatly, but the money stock is still growing at an annual rate of 8.2 %.

How about the velocity of money?

With the onset of the pandemic, the velocity of money crashed. Prior to the pandemic, it was fluctuating around 1.44, i.e. each dollar in the system changed hands approximately 1.44 times on average. After the Covid-19 recession, it fluctuated around a plateau of approximately 1.1. Its percent change from a year ago in Q1 2022 was -0.18 %. Clearly, we are still in the pre-hyperinflation stage of peoples’ expectations.

Finally what about the rate of growth of the GDP?

Real GDP has been declining on average since Q2 2021. In Q1 2022, it fell at a rate of -1.5 percent year-over-year. The dashed red curve, which is the year-over-year percent change in the growth rate shows this decline is accelerating at a rate of -123.8 % per annum. This shows the rate of decline in the supply of needed goods and services is getting larger.

Adding up the numbers, we get the following estimated inflation rate.

The recorded annualized inflation rate for Q1 2022 was 8.1 %. So our estimate is in the ballpark. (The error bars on each of these numbers are not insignificant.) What the three components of inflation strongly suggest is the biggest problem creating inflation is the massive increase in the money supply over the past year. A secondary but growing problem is the economy’s production is decreasing as time progresses. The supply side is sputtering. People have yet to panic over the prospect of hyperinflation, so the velocity of money is not yet a problem. This could soon change.

There are some other statistics that underline this story. For example, the money supply was greatly increased by the Federal Reserve to monetize the buying of government bonds by private individuals and companies. This is done to finance the federal deficit spending. What the Fed did was to allow private banks to create money to be lent to people who wanted to buy government bonds. These bond sales funded increased government programs. Because of these programs, the statistics should show greater government expenditures as a fraction of GDP. Also, the sale of bonds shows up in government accounting books as additional government debt. This is shown in the plot below.

We know from the research of Carmen Reinhart and Kenneth Rogoff that anytime sovereign debt exceeds roughly 80% to 90% of GDP, government borrowing to finance deficit spending begins to crowd companies out of financial markets and begins to kill private investment. In Q1 2022 according to the Federal Reserve, the total federal debt $30.4 trillion while the GDP was $24.4 trillion, i.e. total federal debt was 124.6 % of the GDP.

Yet another problem is the wearing away of the supply side of the economy. The government can try to increase demand for goods and services with all its spending. But if companies’ capability to produce is damaged, just increasing government spending will only result in increased inflation. The nation’s average inventories to sales ratio attests to the damage done to the supply side.

Starting in December 2020 there was a surge in inventories that continued to February 2021. The month-to-month change became negative again in March 2021 when it had a value of -18.8 percent. This index would be considered a bullish indicator in normal times. However, with demand being stoked by government programs and production stifled by many government regulations, a reduction in inventories has led to high inflation. With the government continuing to suppress business production with greater regulations and individuals buying up what is available, the monthly percent change to the inventory-to-sales ratio was -14.8 percent in March 2022. This will lead to even higher inflation in the future.

All of these problems are almost entirely the fault of the Biden Administration. It is true the Ukraine invasion and the global Covid-19 pandemic have contributed to them. However, Biden’s policies are making it impossible for domestic production to substitute for lost foreign supply. Let us take a look at why this is so.

The Ultimate Responsibility of the Biden Administration

American progressives have always favored the demand side of the economy over the supply side. They get this attitude from modern-day Keynesians. (I suspect John Maynard Keynes would rapidly disassociate himself from them, should he come back to life!) From Keynesians, Democrats have obtained the belief that increasing government economic demand would always generate the requisite supply. This attitude, coupled with their historical antipathy toward corporations, has led progressive Democrats to desire increasing government control over corporations. It has also led them to attempt to tax them as much as they dared. The futility of these viewpoints was explored in the posts What the Progressives Don’t Get About Wealth Creation and Corporations and Governments Should NEVER Tax Companies!

The Biden Administration is the culmination of these beliefs. The economic regulations it has imposed on us have done such harm to the economy, we should not be surprised if the coming stagflation hits us with the same force as the Great Depression of the 1930s. I have already written at some length about the economic damage and how Democrats have accomplished the foul deed, so I shall not repeat that here. If you wish to see the details, take a look at the following posts.

• The Idiocy of Joe Biden’s Climate Plan
• Biden’s Administration Should Take a Course in Economics 101
• How Progressive Democrats Try to Violate the Classical Laws of Economics

One last comment about the foreign sources of inflation. The Russian invasion of Ukraine and the global pandemic do affect our inflation by reducing the supply of foreign goods, particularly wheat and oil. However, if the federal government would give U.S. private businesses the freedom to do so, they would be able to replace much or all of the lost foreign goods. As noted above, increased domestic production would help bring down inflation.

In particular, Joe Biden’s war on domestic fossil fuels packs a double whammy. There is the obvious cost of increasing the costs of gas and electric energy (how do you think most electric power gets generated?). However, the war on fossil fuels has increased the cost and reduced the production of farm-grown foods. Gas is needed to power the tractors and other farm machinery. Oil is also needed to make synthetic fertilizers without which we could be a lot hungrier. These fertilizers have allowed global food production to feed a growing global population. Remove them, and a great many people are going to starve to death. Think about all this when you think about domestic fossil fuels. The war on domestic fossil fuels is another reason for the meltdown of the economy.

The Political Impact

Clearly, the political impact of our melting economy does not look good for the Democratic Party. When I began this essay, I suggested we needed to keep track of Arthur Okun’s misery index as a measure of what we could expect politically. Below are plots of the misery index and its components from the beginning of the Trump administration in January 2017 to May 2022 in the Biden Administration.

From the beginning of the Trump Administration until the onset of the Covid-19 pandemic, the misery index drifted slowly downwards. This was primarily due to a slow and steady decline in the unemployment rate, although inflation also drifted downwards in a more stochastic manner. Then as state governments started to shut down their economies in response to Covid, the misery index skyrocketed in March-April 2020 due to a huge rise in unemployment. This was not caused in any way by the Trump economic policies, but by state government responses to limit the spread of covid-19. Then, as federal and local governments began to adjust to the pandemic and reduce the shutdowns, the unemployment rate and the misery index began the return toward more normal values. This process was shortcircuited by the advent of the Biden Administration. As the inflation caused by Biden’s policies grew, it overcame a slowing decline in unemployment. Unemployment seems to have entered a low plateau while inflation continues to rise unabated. In May 2022, the inflation rate was 8.52 %, the U3 unemployment rate was 3.6 % and the misery index was 12.12 %. We are not yet at the level of misery during Carter’s regime, but we are getting there.

The logic of the economic statistics strongly suggests unemployment will start growing soon as companies react to economic stresses. Also, the Biden Administration has done nothing that would actually reduce inflation. The Federal Reserve looks like it might raise interest rates enough to strangle inflation, the way Paul Volcker did in the Carter and Reagan administrations. If this is done without a drastic reduction of government spending, private industry will be strangled along with inflation as they are denied capital assets. Capital instead would flow into government expenditures. Should this scenario continue, we can only expect Democrats to get slaughtered at the polls.

Buckle up. This promises to be one hell of a ride!

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