Biden’s Administration Should Take a Course in Economics 101

Over the last year, President Biden’s administration has repeatedly demonstrated a profound ignorance of basic economics. This ignorance shows their great need for an undergraduate college course in economics. Since the economy provides the resources required to fulfill all of society’s needs, this economic ignorance poses a threat to the well-being — perhaps even the survival — of the republic. We can see this lack of knowledge in the administration’s response to the breakdown of supply chains, inflation, and to the supply of energy.

All of these economic phenomena are interrelated, and their division into these three categories is more than a little superficial. Nevertheless, they are what distress American citizens in their everyday life. We will look at them separately.

Supply Chain Breakdowns

President Biden has ascribed a number of explanations for supply chain disruptions. Yet, as in so much else, these accounts have the quality of a redirection of the responsibility away from himself and his administration. He points to everyone else other than his administration as being accountable. Biden’s explanations include:

• The COVID-19 pandemic.
• Vladimir Putin’s invasion of Ukraine.
• Americans’ increasing demand for goods.

There is a grain of truth in the first two points, but the third is just plain crazy. And even with the first two points, Biden administration changes in economic regulations have prevented the substitution of domestic supply of goods for greatly reduced foreign supplies.

The Covid-19 pandemic and Putin’s invasion of Ukraine do indeed reduce the world’s supply of goods. The world’s supply of wheat is particularly impacted by the Ukraine war. However, Biden’s economic regulations have increased the U.S. inflation rate in several ways (see below). The higher cost of materials and labor then reduces the ability of U.S. producers to substitute for lost foreign supply. Higher costs and Biden’s plans to reduce carbon dioxide emissions combine to reduce American farm and ranch production.

As for the claim that supply chain problems are caused by American economic demands being too high, that assertion puts the cart before the horse. Supply chain problems are caused by a lack of supply, not of demand. To solve supply chain problems, the government would do much better by changing its regulations to encourage U.S. production.

The economic ignorance displayed by Biden’s administratiion demonstrates their urgent need to take a course in economics.

What Is Causing Inflation?

What is causing the inflation now plaguing us? This is a question the Bidon administration should have no excuse for answering wrongly. By definition, an annual inflation rate is the annual percent change in a price index. The inflation rate usually cited is the percent change in the consumer price index (CPI) with the amount of money available expressed as M2 money. The latest CPI inflation rate published by the U.S. Bureau of Labor Statistics was an annualized rate of 7.9 percent for the month of February. The inflation rate for several major categories of goods is shown below.

Note that the only way the CPI inflation rate can be held to 7.9 percent is by leaving out inflation in food and energy. Otherwise, the inflation rate would be well over 10 percent. The problems leading to high inflation in energy will be explored later below.

Let the value of the CPI be denoted by P, the M2 money supply be denoted by M, the velocity of M2 money (the average number of times an M2 dollar changes hands in a year) be represented by V, and the nation’s GDP in some base year’s constant dollars be denoted by y. Then the relationship between these variables is given by

MV is the total dollar value of all transactions in the current year in current dollars. The price index is then the annualized GDP in current dollars compared to the GDP in constant dollars.

Let the annual change in the price index be given by ∆P, with similar expressions for the other variables. Then, the annual inflation rate can be derived as shown below.

This equation tells us the inflation rate increases with an increase in the amount of money in circulation and in the velocity of money, and decreases with an increase in the GDP. So what is causing inflationary changes in these three aggregate variables?

The biggest factor increasing inflation is the growth of the M2 money supply.

The huge increase in the money supply starting at the beginning of 2020 was because of Trump’s and Biden’s rescue plans for the economy. Because the expenditures mandated by the authorizing bills were so massive (a total of $3.9 trillion), the Federal Reserve had no choice but to increase the money supply to monetize the additional debt. After the maximum annualized growth in the money supply (27.6 % in February 2021), the growth rate fell until it reached 10.7 % at the end of February 2022. This is clearly greatly inflationary.

The second biggest factor is the decreasing production of certain high-value parts of the GDP. Many of these are clearly related to the supply chain disruptions discussed above. They include decreasing fossil fuel production and agriculture production. As demonstrated in the Bureau of Labor Statistics statistics of major inflationary categories shown above, inflation caused by a lack of needed energy is the greatest source of problems.

Finally, there is the velocity-of-money factor. Its value and its change depend sensitively on the psychological mood of the public. When inflation is low (below around 10 %), people will spend less to conserve their dollars for a time when inflation starts falling. However, when the economy starts to enter a hyperinflationary environment (hyperinflation is a very high and accelerating inflation rate), people begin to panic and spend their money as fast as possible before it loses more of its value. We are not yet in such an environment, as demonstrated in the plots below.

From the graph, it should be clear that we are still in the inflationary environment where most people are holding on to their money. Nevertheless, M2 velocity growth is currently increasing from -2.79 % in Q3 2021 to -0.97 % in Q4. This value is clearly mildly deflationary, but is greatly overwhelmed by the percent changes in the money supply and in the GDP growth.

The Biden administration appears oblivious to these facts. In fact, in July last year, Biden had claimed that he could conquer inflation by vastly increasing government expenditures. He asserted,

“My Build Back Better plan will be a force for achieving lower prices for Americans looking ahead. It’s another reason why these investments are so important.“

President Joe Biden

Apparently, he believes increasing government expenditures by trillions of dollars (up to $2 trillion for the Build Back Better bill), would be noninflationary. However with government expenditures already greater than revenues, the Build Back Better bill would have to be financed by the sale of government bonds. This would take money out of the economy and thereby decrease aggregate demand. To avoid this depressing effect, the Federal Reserve creates “fiat money” and injects it into the banking system. The dollars injected can then be multiplied further by fractional reserve banking. Overall the money supply is increased by more than the financed government expenditure.

Biden seems to understand none of this. He urgently needs to take the equivalent of a basic course in economics.

What Is Limiting Our Energy Supplies?

The cost of energy is intimately connected to both existing supply chain disruptions and to inflation. During the previous Trump administration, the United States was moving toward self-sufficiency in domestic fossil fuel production. (There are arguments about whether it was actually achieved. See here and here.) In fact, the U.S. was exporting such fuels to other nations under Trump. Whether or not we had actually achieved self-sufficiency, we were moving toward it.

Then came the Biden administration. Even while he was still a presidential candidate, he was declaiming to everyone how he wanted to destroy America’s fossil fuel industries.

Then, on the first day of his administration, he signed three executive orders that attacked domestic fossil fuel production. One was an order to halt new oil and gas leases on federal lands and waters.

The major reason for these policies was the fantasy that human carbon dioxide emissions pose an existential threat by warming the globe. Nothing could be further from the truth, as demonstrated in the post The Idiocy of Joe Biden’s Climate Plan. The U.S. public is asked to pay a very big price for nothing at all.

Yet, the inflation in gas and energy prices has caused the Biden administration to search for scapegoats for the inflationary results of his policies. One recent and convenient explanation was that Vladimir Putin’s invasion of Ukraine necessitated economic sanctions that has disrupted Russian supply chains with the West. This includes Russian oil and gas supplies for the U.S. However, these assertions are unlikely to be persuasive with the American electorate. For one thing, Russia is not a key trading partner with the U.S., accounting for only 8 % of U.S. imported oil and for only 2 % of American energy supplies. In addition, U.S. energy inflation was present for a long time prior to the Russian Ukraine invasion. In the 12 months prior to December 2021, gas prices had already increased by 51 % for regular unleaded gas at the pump. Biden’s sanctions on Russia will, of course, make the situation even worse. The only way Biden could easily ameliorate his necessary Russian sanctions would be to increase U.S. domestic production of oil and gas.

Therefore, Biden needs yet another scapegoat to divert the blame away from himself. He thinks he has found it in an old and hoary progressive standby. Blame the private companies themselves that produce fossil fuels! As the progressive narratives go, capitalist corporations will maximize what they earn by seizing an excuse to hold production down to artificially raise prices. The economic ignorance this assertion exposes is the following: Corporate earnings are maximized with the maximum product of sales volume with price. Since sales volume increases only with decreasing prices (see the classic Law of Supply and Demand), there is a severe limit to how much companies can increase prices. Corporate earnings (and therefore profits) are maximized at the good’s equilibrium market price, where the good’s supply curve intersects its demand curve.

The Biden administration tries to misdirect our attention by noting oil companies are not drilling at all the sites leased to them by the federal government. However, once a site is leased, the leasing company must satisfy a complex regulatory process before it can begin drilling. This is also true for drilling on private land not owned by the federal government. Ed Hirs, an energy fellow at the University of Houston, noted the following:

Federal leases…are subject to environmental studies. They’re also subject to lawsuits filed by neighbors, by municipalities, by counties and state governments. And so it’s become a more arduous process.

Ed Hirs, University of Houston

It does not help if the government sells leases to drill, but then withdraws permission for that by other means.

In all of the economic problems described above, the Biden administration has shown it has little understanding of the nature of economic reality. This progressive economic ignorance has made stagflation inevitable in the very near future.

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