The latest report showing negative economic growth for the first quarter of the year is a painful reminder of the damage inflation can do. The current inflation rate of 8.5% is the highest in 40 years. But few policymakers or Fed governors seem to have learned lessons from the recent bout of price hikes – how it began, the economic devastation it caused, and how we got out of it. We are surprised when we hear investment gurus arguing that because inflation often means increased consumer demand, it is good for the economy and the stock market.
truly? Let’s go back to 1974, the early stages of that long stretch of inflation. That year, one of us, Mr. Laffer, wrote on these pages what became a controversial and influential article entitled “The Bitter Fruits of Devaluation”. Inflation, of course, is a form of currency devaluation.
Two years earlier, the Nixon administration intentionally devalued the dollar in the mistaken belief that a cheaper dollar would stimulate growth and employment while reducing the US trade deficit. Laffer’s article warned that this policy would wreak economic havoc and cause a stock market train wreck. This is exactly what happened.
Those who suffered the most were middle-class workers who were hurt by rising prices, especially in the energy sector, who far outpaced wage increases. Between 1972 and 1981—under Presidents Nixon, Gerald Ford, and Jimmy Carter—the hourly wage for workers rose from $4 to nearly $7, a nearly 70% increase. But after accounting for inflation, workers are getting poorer due to the purchasing power of wages He fell By about 12%. Is it any wonder that Ford and Mr. Carter are out of office? This is exactly what workers face today with wages increasing 5.6% over the past year, but consumer prices rising 8.5%. Back then, as now, the White House and the Federal Reserve said inflation would be temporary and blamed it on global factors beyond their control.
What about the stock market and the wealth of Americans? Mr. Laffer’s warning of a bear market turned out to be spot-on. As the nearby chart shows, the Dow Jones Industrial Average rose briefly above 1000 in the mid-1960s and then bottomed at 777 in the summer of 1982 – a 22% drop in stock values at face value.
But investors, like workers, care about them fact return. Adjusted for inflation, the industry average (and the S&P 500) has fallen over that period by more than 70% — the worst performance of stocks in 15 years since the 1929 crash. President Ronald Reagan and Federal Reserve Chairman Paul Volcker had to tiring 11% out of the system by a return to a stable dollar system along with supply-side tax cuts that encouraged the production of more goods and services. A bull market ensued, with the Dow Jones Industrial Average rising more than 30,000 between 1982 and 2022. Over a 40-year period, inflation averaged 3% until the arrival of President Biden and the mobilization of modern monetary theory.
So what were the lessons learned from the economic tsunami of the 1970s? First, inflation is a double whammy on Americans’ paychecks and lifetime savings. Proponents of the request are wrong. Their argument is that Mr. Biden’s multiple government spending and welfare programs are pumping more money into people’s pockets which translates into higher consumer demand, which means more corporate profits.
This argument is not exhaustive. In the past 12 months, workers have seen the purchasing power of their paychecks fall 3% — a faster pace than at any time in at least a decade. For shareholders, those buttery profits reported by companies may be bogus. Over the past year, stock markets have fallen slightly in nominal terms, but when adjusted for inflation, values have fallen by more than 10%.
The collapse of the 1970s in workers’ incomes was not just due to accelerating inflation. The decade was also an era of increased regulation, massive expansion of the welfare state, wage and price controls — making inflation worse — and increasing global tariffs. Because capital gains tax is not categorized by inflation, many shareholders have paid taxes on purely inflationary gains – a real tax rate of over 100%.
With Mr. Biden in the White House, doesn’t this set of policies sound familiar? This month, even as the economy shrank 1.4% in the first quarter, Biden’s White House budget requested $2.5 trillion in tax increases, including a tax on trillions of dollars in unrealized capital gains. The White House and House Speaker Nancy Pelosi are still selling their $5 trillion bill to build back better. Imagine how high inflation would be today if Senators Joe Manchin and Kirsten Senema had not saved the day by blocking that law.
Each business cycle is unique, and comparing one era to another often leads to incorrect conclusions. We don’t think it’s too late for a sharp policy reversal to prevent a recession and market deflation.
Here’s our current bitter fruit warning: If Mr. Biden doesn’t alter its course and the bear market cycle from the late 1960s through the early 1980s, the Dow Jones Industrial Average will drop from its recent high of 36,800 to below 29,500 in 2038. To adjust with Inflation, the indicator will decrease further.
Do you still think that a little inflation – which often turns into big inflation – is good for investors?
Mr. Laffer is President of Laffer Associates. Mr. Moore is a co-founder of Unleash Prosperity and an economist at the Heritage Foundation. Mr. Laffer was a member of the Reagan Economic Policy Advisory Board, and Mr. Moore served in the Reagan-era Office of Management and Budget.
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