Coming Soon: Dubious Claims about Inflation’s Peak

T he Kafkaesque Democratic chatter about the economy is beyond creepy. Nearly everything that the mainstream media and the Democrats have been telling us about the economy has been wrong, and they keep doubling down. First, we had modern monetary theory, so the government could mail checks to everyone, and it would not cause inflation. Then, when inflation was obvious to all, they said not to worry because it was transitory. After it stopped being temporary, it became Putin’s fault, even though it started well before the war in Ukraine. The rise in oil price movement was Putin’s price hike. But U.S. production is down relative to peak far more than Russian. So whose price hike is it?

President Biden himself told us that the Democrats inherited an economy on the ropes, and he revived it. If there is a recession coming, it will be off a year or two, the same brilliant economists tell us. But of course, GDP was growing more than 6 percent when he took office, and the Atlanta Fed’s GDPNow is currently at -1.6 percent for the second quarter, after posting a similar drop in the first. The economy has turned around, but not in the direction they mean.

In a new all-time low for economic communication, Biden is even claiming that two negative quarters in a row are not a recession. Well, since 1949, we have had two or more negative quarters in a row ten times. Every one of those was subsequently deemed to be in a recession by the official referee of such things, the NBER. But sure, the White House might add that it’s a mild recession. Actually, if GDPNow is correct, it will likely presage as deep a recession as during the financial crisis and in 1982, when the Fed created what is widely agreed to be a deep recession to tame inflation.

It goes on. Sure, maybe the output data are weak, we hear from the same quarters, but the labor market is strong, so we are not in a recession. This has been partly true looking at the jobs report, but there is a major flaw here.

Labor data almost always lag the cycle. Hiring someone takes time, and can cost a lot of money.  Firms have to interview people, they have to run advertisements, and maybe pay a headhunter.  When sales start to go south, it doesn’t make sense to let people go because then the firm has to eat the fixed costs they had sunk into hiring. And when things come back, they will have to spend even more on the fixed cost of hiring new workers. So they tend to fire slowly in the downturn, and hire slowly in the upturn.

So what do the labor data look like when there is a recession? Typically, a quarter or two after the recession starts, layoffs begin and initial claims for unemployment insurance start to climb above 250,000 per week. With the first quarter being negative, and the second quarter looking that way as well, it is about time for the labor market to start to turn.

So what do we see in the data? Initial claims have climbed steadily from 200,000 per week to last week’s number of 251,000. In other words, things look just like most other recessions. Another argument bites the dust.

Assuming for the case of argument that we are in a recession, the natural question is, what happens next to inflation? The answer is that topline inflation and core inflation start to go down because people who lost their jobs consume less, and people worried about losing their jobs save more. In addition, construction stops, so commodities, such as copper, start to see their prices drop as well.

Looking at the price data, the recession-driven retrenchment of prices is clearly already underway. With people cutting back on vacations and discretionary travel, gasoline prices are down. Brent crude is down from $123 per barrel in early June to $104 per barrel today. Copper is down more than 20 percent, meanwhile gold is down from $1,875 to $1,712 over the same time period. Even housing prices are looking vulnerable, after a gangbuster year.

These recession-driven price drops are good news on the inflation front, but bad news for the economy. Indeed, they are strong evidence that the recession is real. But they are not policy-driven, just the natural result of wages failing to keep up with prices. Real incomes are down more than 4 percent this year, so real output will be down too, and demand will drop accordingly.

So inflation has likely peaked, but history suggests that inflation spikes (such as this one) take a long time to work out of the system. While inflation will likely start to head south, it is very unlikely that it will be close to the Fed’s 2 percent target before the next president is inaugurated.

But as the prices drop, we will see White House repeat what it said this week, probably all the way through midterm election. First, deny that we are in a recession. Second, there will be an absurd attempt to claim credit for the reduction in inflation: “Gasoline prices are down because President Biden took bold action to release oil from the strategic reserve! Other prices are down because he fixed the supply chain problems!”

But students of economic history know better. Indeed, there will be no controversy whatsoever when the story of this year is written, and that history is worth keeping in mind while the spin machine spins. A surge in spending created fully foreseeable inflation. Incomes did not keep up with inflation, so real income and real production declined. The inflation was high enough that the Fed had to take tough action, even as the economy was declining. A sharp drop in output followed, and inflation headed back toward the Fed’s target, led by commodity prices. As wages tried to catch up to inflation, a wage price spiral offset the effects of the recession somewhat, and inflation stayed elevated for some time.