The economic establishment is blind to the scale of chaos to come

biden economy
Americans are unimpressed by Biden's economic track record, despite bumper growth - REUTERS/Nathan Howard/File Photo

It is no secret that the US is currently experiencing a bout of economic ennui.

In recent months, surveys have shown that confidence in President Biden’s stewardship of the economy is at historic lows.

A poll in the important swing state of Pennsylvania this week shows that Donald Trump leads Joe Biden on this issue by double digits. Since the economy is arguably the dominant factor in most American elections, it seems likely that Biden will lose based on his mismanagement.

Democrats are trying desperately to figure out what is going on. Biden’s supporters within the party highlight the fact that the American economy is growing robustly. In the first quarter of 2024, the US economy expanded 3pc year on year. These are the sorts of growth numbers Britain and other European nations can only dream of. Yet the American public seem less than impressed.

Answers are coming from outside Biden’s inner circle. A few weeks ago, former treasury secretary Larry Summer released a paper written alongside other economists. In it, the authors made a shocking claim: if inflation was measured in the same way that it was measured during the last bout of price rises in the 1970s, data showed that it peaked at 18pc in November 2022. This is far higher than the 9.1pc peak inflation shown by the official data.

The reason for this discrepancy is that, since the 1970s, economists have removed the cost of borrowing from the Consumer Price Index (CPI). The motivations here were not nefarious. The reasoning of the statisticians had something to it.

They argued that since borrowing costs are determined by central bank policy and central bank policy aims at suppressing inflation, including borrowing costs in the CPI created a logical loop. Yet, despite the motivation for changing the statistical metric being benign, it is clear that when trying to measure the pain inflation imposes on consumers, borrowing costs must be considered.

Summers and his co-authors go as far as any statistical economist can go in proving this. They show that a combined metric measuring inflation and unemployment – labelled the “misery index” – typically tracks consumer sentiment.

But as inflation took off under the Biden administration, the two series diverged. Summers and his co-authors then go on to show that if they use the older measure of CPI, lo and behold, the two series align once more.

There is little doubt that Summers and his co-authors have solved the puzzle. Supporters of the Biden administration can point to robust GDP growth all they want. The reality is that most people in the US have seen their costs rise by nearly a fifth during Biden’s tenure as president.

It barely needs be said that wages have nowhere near kept up with this increase in costs. The Biden administration may try to channel Groucho Marx, asking voters “who are you going to believe, me or your lying eyes?” but most people know they’ve seen their living standards decline.

The old-but-new inflation metric that Summers and his co-authors have come up with is not the only interesting inflation-related datapoint circulating right now.

This week, Bloomberg columnist John Authers highlighted a very interesting chart. The University of Michigan regularly surveys people on the future trajectory of inflation. Typically, the mean of the sample is roughly equivalent to the median of the sample. But not today. The median is now much higher than the mean.

What does this mean? Simply put, a significant minority of people are far more pessimistic regarding inflation in the future than the average person. This is not just a small percentage of inflation-phobes. Presumably they always exist. No, a significant number of Americans who typically have an average view of future inflation currently think that inflation will remain much higher in the future.

Market analysts appear to be chalking this up to partisan politics. They argue that these people are strongly opposed to President Biden and project that opposition onto their inflation expectations. In effect, this argument states that the extreme pessimism we see in the median inflation survey data is due to MAGA Republicans, passionate opponents of
President Biden and the Democratic Party.

Perhaps there is some truth to this. But there is another explanation: these people are worried about the state of the world. Economists love to think of metrics like inflation in a technocratic manner – attributing it to interest rate policy or the money supply. But the reality is that most periods of serious inflation we see in human history were ultimately due to war and conflict.

That is precisely what we are seeing again today. The inflation of today was originally set off because of a virus. It was then exacerbated by a war in Eastern Europe. And now it is sticking around, in part at least, due to tensions in the Middle East and a curious blockade-by-a-state-without-a-navy in the Red Sea.

Future inflation may well be driven by the kneejerk reaction of many countries to these developments and their fall into being seduced by aggressive protectionism.

Perhaps this sizeable minority of people who think that inflation will be much higher moving forward are reading the newspaper headlines and connecting the dots. Perhaps they have concluded that there is a link between the global chaos we see all around us and their declining living standards. Yes, maybe some of them blame the turmoil on Biden, but ultimately, the causal link is robust.

Here is a worrying thought: maybe this sizeable minority of Americans is correct. Maybe continued global turmoil and Western protectionism will generate inflation in the coming years. And maybe our living standards will fall accordingly.