The recent report showing negative economic growth for the first quarter of the year is a painful reminder of the damage inflation can cause. The current inflation rate of 8.5% is the highest in 40 years. But few policymakers or Federal Reserve governors seem to have learned the lessons of the last price spike — how it started, the economic devastation it caused, and how we got out of it. We wince when we hear investment gurus claim that because inflation often means increased consumer demand, it’s good for the economy and the stock market.

Really? Let’s go back to 1974, the early stages of this long period of inflation. That year, one of us, Mr. Laffer, wrote on these pages what became a controversial and influential article with the title “The Bitter Fruits of Devaluation”. Inflation is, of course, a form of currency devaluation.

Two years earlier, the Nixon administration had intentionally devalued the dollar in the mistaken belief that a cheaper dollar would boost growth and jobs while reducing the US trade deficit. Laffer’s article warned that this policy would wreak economic havoc and wreck the stock market. This is precisely what happened.

Those who have suffered the most are middle-class workers affected by rising prices, especially of energy, far exceeding wage increases. Between 1972 and 1981, under Presidents Nixon, Gerald Ford and Jimmy Carter, the hourly wage of workers rose from $4 to nearly $7, a gain of about 70%. But after controlling for inflation, workers became poorer because the purchasing power of wages fell by about 12%. Is it any wonder that Ford and Mr. Carter were removed from their positions? This is exactly what workers are facing today with wages up 5.6% over the past year, but consumer prices up 8.5%. Then like now, the White House and the Fed said the 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 has proven true. As the chart opposite shows, the Dow Jones Industrial Average briefly climbed above 1000 in the mid-1960s, then hit a low of 777 in the summer of 1982, a 22% reduction in value. shares in nominal terms.


But investors, like workers, care about their real to return to. Adjusted for inflation, the industrial average (and the S&P 500) fell more than 70% during this period, the worst 15-year stock market performance since the crash of 1929. President Ronald Reagan and President of the Fed, Paul Volcker, had to sweat the 11% inflation out of the system thanks to a return to a stable dollar regime as well as supply-side tax cuts that encouraged the production of more goods and services. A bull market ensued, with the Dow Jones Industrial Average rising to over 30,000 between 1982 and 2022. During this 40-year period, inflation averaged 3%, until the arrival of the President Biden and the Modern Monetary Theory crowd.

So what are the lessons of the economic tsunami of the 1970s? First, inflation is a double whammy to Americans’ wages and lifetime savings. The plaintiffs are wrong. Their argument is that Mr. Biden’s trillions of dollars in government spending and social programs put more money in people’s pockets, which translates into increased consumer demand, which means increased profits. companies.

This argument does not hold water. Over the past 12 months, workers have seen the purchasing power of their paychecks decline by 3%, a faster rate than at any time in at least a decade. For shareholders, those bubbly earnings that companies have reported may be illusory. 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 workers’ incomes and the stock market of the 1970s was not only due to runaway inflation. The decade was also an era of increasing regulation, vast expansion of the welfare state, wage and price controls – which worsened inflation – and rising global tariffs. Because capital gains tax is not indexed to inflation, many shareholders have paid purely inflationary gains taxes, an effective tax rate of over 100%.

With Mr. Biden in the White House, doesn’t this constellation of policies sound familiar? This month, even though the economy shrank 1.4% in the first quarter, the White House Biden budget called for $2.5 trillion in tax increases, including a tax on billions of dollars in unrealized capital gains. The White House and Speaker Nancy Pelosi are still peddling their $5 trillion Build Back Better Bill. Imagine how much higher inflation would be today if the senses. Joe Manchin and Kyrsten Sinema did not save the day by blocking this bill.

Each economic cycle is unique and comparisons from one era to another often yield erroneous conclusions. We don’t think it’s too late for a drastic policy reversal to prevent a recession and market contraction.

Here is our current bitter fruit warning: If Mr. Biden does not change course and the bear market cycle of the late 60s to early 80s returns, the Dow Jones Industrial Average would fall from its recent high of 36,800 to less to 29,500 in 2038. Adjusting for inflation, the index would fall even further.

Still think a little inflation, which often metastasizes into a lot of inflation, is good for investors?

Mr. Laffer is President of Laffer Associates. Mr. Moore is a co-founder of the Committee to Unleash Prosperity and an economist at the Heritage Foundation. Mr. Laffer was a member of Reagan’s Economic Policy Advisory Council and Mr. Moore served in the Office of Management and Budget under Reagan.

Journal editorial report: The party begins its long ascent to mid-terms. Images: Shutterstock/Zuma Press Composite: Mark Kelly

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