How skyhigh inflation could haunt Biden in midterms

Government stimulus cheques have helped to push prices up, reports Szu Ping Chan from the Rust Belt city of Cleveland, Ohio

Cleveland’s skyline has changed dramatically in the past century. The plants that used to make gun and engine parts for B-29 aircraft during the Second World War are long closed, and the city is now best known for its medical breakthroughs via the Cleveland Clinic, which employs more than 50,000 people.

A huge retail complex sits on a former steel finishing mill site in the heart of the city, though the blast furnaces and chimneys that tower over the now abandoned plants serve as a reminder that this is Rust Belt territory.

But whether it is cars, chemicals or cataract surgery, businesses in Cleveland are facing the same challenges. Prices are rising. Talent is scarce. And economic and political uncertainty is growing.

Americans vote in the midterms this week against a backdrop of price rises that have hit a 40-year high. Inflation, as measured by the consumer prices index, currently stands at 8.2pc. The Federal Reserve has increased interest rates to their highest in 14 years to try to keep a lid on price growth, pushing up borrowing costs for households and businesses in the process.

Petrol prices are above $5 a gallon in some parts of the country, almost double the price when Joe Biden was elected president in 2020. The cost of living has jumped.

Many voters will have this on their minds as they head to the ballot box. A recent CNN poll showed 71pc of Republican voters believed the economy was the biggest issue when deciding how to vote in the midterms, compared with 27pc of Democrats.

President Biden’s approval rating has dropped to a new low over fears about how long stubbornly high inflation will last. Republicans have sharpened their criticisms of Biden’s management of the economy. Attack ads have even dubbed it “Bidenflation”. Meanwhile, Donald Trump is waiting in the wings to have another shot at the White House. The former president is expected to announce a 2024 presidential bid after next week’s poll.

Concerns about inflation stretch from the living room to the boardroom. “Businesses are certainly concerned about inflation,” says Baiju Shah, president of the Greater Cleveland Partnership.

“Many are passing on higher costs to customers in order to remain in business but they’re not able to pass on everything because of competition.”

Strong demand has helped to protect profit margins, but many companies are also facing higher staffing costs too. “Worries about labour costs are especially acute for financial roles,” says Shah. “They’ve already been paying significantly more, but companies here are also competing with New York and San Francisco on talent costs because remote work has opened up opportunities there, so that’s felt.”

Shah says entry level workers are also commanding higher salaries. “Starting wages are up dramatically,” he says. “Employers are paying significant signing bonuses for production, retail or service workers to join their organisations. And they’re concerned about the ability to retain those workers in spite of greater wages because of the competitive environment. Cleveland’s Lincoln Electric started offering £10,000 sign-on bonuses last year to try to tempt skilled workers to apply.

US workers complain everything is going up – rents, restaurant meals, cars, food. Analysis by Goldman Sachs shows the price of around half of the inflation basket tracked by the Fed is rising by more than 6pc a year.

Parts shortages during the pandemic led to a surge in second-hand car prices, which is only just starting to abate.

Randy Krozner, a former Fed official, knows this all too well. He moved back to Chicago recently after living in London for more than two years and he thought it was time to buy a new car when his 2004 Audi A4 wouldn’t start after laying dormant for that time. “The question was, do I spend thousands of dollars to get it working again? Or do I just buy a new one? And it was so expensive to buy any car that I decided to keep it running.”

Krozner believes the post-pandemic surge in inflation will come back to haunt him. “The Biden team made a miscalculation,” he says. “They were focusing on spending more to garner votes and they thought that would make people feel happy. But their economic stimulus came on top of a lot of stimulus that had come before that.”

The professor of economics at Chicago Booth says Covid took the economy into uncharted territory.

“One thing that nobody fully anticipated is how difficult it is to restart an economy that has been completely shut down,” he says. “You can’t just turn the lights off and then back on again. And demand shifted dramatically within a few months. Peloton is a classic example, where

‘They were focusing on spending more to garner votes’

‘When you have a demand stimulus and supply constraints, prices go up’

everybody wanted one, and then by the time they invested enough to make more, nobody wanted a Peloton. And it was very difficult to predict how that demand would shift.”

Krozner says this, combined with big stimulus cheques from the government, was only going to end one way. “The Biden administration thought it would be positive for them because it would keep the unemployment rate low. But the chickens were always coming home to roost. When you have a demand stimulus and supply constraints, the thing that can happen is that prices go up.”

History suggests getting inflation down is hard once it reaches a certain level. Deutsche Bank used data for 50 central banks in developed and emerging markets spanning 100 years to show that once inflation spikes above 8pc, it takes around two years just to drop to 6pc, a level at which it remains for a further three years. The research suggests that inflation in the US could remain stuck at 4pc for a while. As Jim Reid at Deutsche highlights: “The current consensus expects us to be back at or even below 3pc just two years after we initially moved above 8pc. This is far from impossible, but it would be around four percentage points beneath the median outcome.”

Polls suggest Republicans will regain control of the House of Representatives, although the fate of the Senate is much less certain. Back in Cleveland, Baiju Shah at Greater Cleveland Partnership says divided government can actually be good for business. “The irony is it creates a little bit more stability for businesses, because it’s very difficult to pass significant changes to policy when you’ve got division of responsibility between the House, the Senate and the executive branch.

“If we ended up in that situation, we’d get two years in which at least we’ll know what we’re working with.”

A more immediate concern is whether the world’s largest economy is headed for recession. With interest rates at 4pc and likely to climb further, Krozner says this is “highly likely”, adding that unemployment will probably need to rise to 5pc, from the current 3.7pc in order for the economy to cool enough to get inflation back to the Fed’s 2pc target.

Krozner says this process is likely to take a while. “I would say it will take at least until 2024 before we’re close to that 2pc target,” he predicts. “Inflation has just been so high, so even as it starts to come down, people are going to be saying, my pay rises have been 5pc, but my cost of living has gone up 8pc. So even if inflation comes down to 4pc next year, I still need to make up for that. So I think you’re going to still see elevated wage demands for a while yet.”