State of the economy
Biden left more questions than answers about his economic policies in his SOTU address.
Bottom Line
President Joe Biden's State of the Union speech was a prime opportunity to address the U.S. economy. Instead, he gave a deeply partisan campaign speech, marking the start of his bid for re-election. He certainly jazzed his Democratic base, but to our mind, left too many unanswered questions about his economic stewardship, specifically inflation, the labor market, gross domestic product (GDP) growth, the federal debt and deficit, and tax policy.
Inflation receding Over the last four decades, nominal CPI inflation averaged a benign 2.8% year-over-year, and Biden inherited a 1.4% rate in January 2021. Over the next 18 months, however, inflation spiked to 9.1%, the worst in 41 years. How did that happen?
The Federal Reserve identified three causes in a white paper published at its annual monetary policy symposium in August 2022. The authors contend that excessive and unnecessary fiscal spending accounted for 60% of the problem and that another 20% stemmed from the Fed tightening monetary policy in March 2022—a year later than it should have. The last culprit was the supply-chain bottleneck caused by the Covid pandemic. When the dearth of goods met consumers flush with cash from overly generous government stimulus, too much money chased too few goods.
To be sure, from its peak 20 months ago, annualized CPI has fallen sharply, touching 3.1% in January 2024. But it rose a tick to 3.2% in Feburary and is still well above pre-pandemic levels on key items. Housing and gasoline, for example, are 40% higher, and groceries 20%. So, Biden’s scapegoating of corporate greed might not resonate with voters.
Labor market softening? Just before the Covid pandemic hit the U.S. in February 2020, the unemployment rate sat at a 51-year low of 3.5%. As the government shut the country down, over the next two months it spiked, reaching a record high of 14.8% in April. The National Bureau of Economic Research chose that month for the endpoint of the Covid recession, and not long after, the unemployment rate plunged, touching 6.4% in January 2021. From there, Biden drove it down to a 53-year low of 3.4% in April 2023. But over the past 10 months, the trend has reversed slightly, rising to a 2-year high of 3.9% in February.
That increase of 0.5% over the past 10 months brings the Sahm Rule into focus, which states that, if unemployment rises 0.5% or more on a rolling 3-month basis over a year’s time, the economy typically slows, perhaps into recession.
Excessive fiscal stimulus We have no problem with Congress passing the $2.2 trillion CARES Act in March 2020. It certainly helped to lift the economy from the shortest, but deepest recession in U.S. history. But President Trump’s $900 billion Phase 4 pandemic relief stimulus in December 2020 was unnecessary, as was Biden’s $1.9 trillion American Rescue Plan in March 2021. We liked the bipartisan $1.2 trillion infrastructure deal in November 2021, but disagreed with the administration’s $1.4 trillion Inflation Reduction Act of September 2022.
V-bottom recovery Due to the pandemic, second quarter 2020 GDP plunged 28% quarter-on-quarter annualized, making it the worst quarter in U.S. history. But when the economy re-opened, third-quarter GDP surged 34.8%, the best in history. That means that the GDP output gap created by the pandemic-triggered recession fully closed by the first quarter of 2021. We at Federated Hermes thought this would happen by mid-2021, but the economy recovered more quickly than we had expected.
Never let a crisis go to waste In his address, Biden said the government needed to inject the more than $5 trillion to revive an economy on the brink. But it appears the economy was already raking, which suggests we did not need the massive fiscal stimulus. It seems Washington ripped a page from the Gospel according to Rahm Emanuel, who once said politicians should never let a good crisis go to waste.
Collateral damage Our research friends at Strategas point out that, over the first 232 years of America’s existence (through the end of President George W. Bush’s second term), the U.S. had amassed $10 trillion in debt. But over the past 15 years spanning three presidential administrations (Obama, Trump and Biden), that figure more than tripled to $34.4 trillion today. That amounts to a compound annual growth rate of 8.5%, well above the GDP growth and inflation rates. The debt-to- GDP ratio under Bush in 2008 was 60%; it is now 125%. From his podium in the chamber of the House of Representatives, Biden claimed his fiscal policies have reduced the deficit, but we aren’t buying it.
Pay your fair share Biden threw red meat to his base in his speech. He proposed to increase social spending and to raise taxes on the rich (those making over $400,000) and corporations he characterized as not paying their “fair share” of taxes. But according to the IRS, the top 10% of taxpayers are already chipping in more than 70% of total federal taxes, while the bottom half of taxpayers are paying less than 3%. So who, exactly, is not paying their fair share of taxes?
Moreover, there’s a risk to the economy with this fiscal policy scheme. The top 20% of Americans by income disproportionately account for 40% of consumer spending, while the bottom 40% account for only 20%. Because consumer spending accounts for 70% of GDP, raising marginal tax rates too high could have a deleterious impact on growth, possibly pushing the economy over the edge into recession in 2025.
Biden told the nation that the era of trickle-down economics is over, reminding us that his approach is to grow the economy from the bottom up and the middle out. But that has never worked in the economic history of the U.S. Compare President Reagan’s top-down approach versus President Obama’s bottom-up approach. Reagan’s GDP was twice that of Obama’s (4% versus 2%) over their 8-year terms.