In the late 1970s, the U.S. experienced an economic condition known as stagflation.  This meant the economy was not growing, yet prices were rapidly rising.  One measure of just how bad things were was the Misery Index. This was found by adding the inflation rate to the unemployment rate. 

Biden’s stated economic policies will significantly raise the Misery Index.

Most economists would probably say that a misery index of 7 or less is desirable.  During the late 70s it hit nearly 20.  That meant there were years when the inflation rate or the unemployment rate exceeded 10%.

Before the pandemic, the prior administration’s policies had the number down to 5. 

The 1970s stagflation occurred because rising wages and commodity prices significantly increased  the cost to produce goods and services. At the same time, the market could not respond to the resulting higher price by expanding output. That meant higher prices and no growth or stagflation.

The response that solved the problem was simply to create policies that enabled business to respond to market conditions by increasing their output.  That would put downward pressure on prices, increase competition and increase growth. Significantly reduced tax rates for all income earners and corporations set the stage.  Monetary policy was accommodating, resulting in low interest rates.

As a result of the tax cut, consumers had more money to spend.  More importantly, business had the needed capital to invest, which mostly came from high-income earners and corporations. The unemployment rate fell as annual economic growth accelerated to 7.5% by 1984.

Stagflation and the resulting high misery index could return if Biden’s stated economic policies are fully enacted.  The reason will be very simple: business will not be able to respond to market conditions by expanding output. Business will be forced to respond by raising prices.

In other words, Biden’s push to give people free goods and services creates a greater demand in the market.  He wants to pay for those giveaways by eliminating the 2018 tax cuts and by further raising taxes on the highest income earners and on the wealthiest Americans. 

Biden’s policies will also result in much higher energy prices.  Energy is used in the entire business process meaning the increased cost will put upward pressure on all prices.

He wants to raise the top income tax bracket to at least 40%.  And he wants to raise the capital gains tax rate to 40%.  Biden says the wealthy should pay their fair share.

But the higher tax rates will force business to an undesired response to market conditions.

In other words, business can respond to the increasing demand in one of two ways.  The desired way is to increase output to meet the new demand.  This is usually the most profitable course for business.  And it keeps prices stable while output increasing.

The second, less desirable way, which occurs if business is unable to increase output, is to raise the price.  This way results in higher prices and a stagnant amount of output.  Biden’s policies will result in more businesses being forced to choose this way.

Today’s economy is very capital intensive.  In manufacturing, we no longer have an assembly line with 100 workers.  Today there are 90 robots and 10 workers on the line.  This enables U.S. manufacturers to keep the cost down low enough to compete with the low-wage foreign labor.

Even in the service industry, nearly all employees have capital goods that make them much more productive.

By raising capital gains tax rates, corporate tax rates, and maximum income tax rates,  there is a reduction in capital formation, meaning there is less capital available to business. At the same time, increased government spending drives up the deficit and the public debt.  That means trillions more dollars that are not available to business.

Last year’s more than $3 trillion deficit increased the public debt to $26 trillion.  Congress recently passed another $900 billion package which will increase the public debt to $27 trillion.  The President is pushing for another near $2 trillion stimulus package.  That will take the debt to $29 trillion.

There is no mechanism for every repaying the debt.  It is simply rolled over every time a bond matures, unless there is a surplus in the government’s budget, which doesn’t seem likely anytime soon.  That means $29 trillion will be forever removed from capital markets.  And less capital will be available to business.

If Biden is successful in implementing his stated economic policies which reduce capital formation and continue with large deficits, there will be a capital shortage. Then business will be forced to respond to the market by raising prices and not increasing output. 

Biden’s economic policies will lead to a lot of misery.

Image: Zfigueroa