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Should we actually be worried about deflation?

Some investors think inflation isn't the problem

Photo (c) Javier Ghersi - Getty Images
For the last few months consumer prices, as tracked by the U.S. Labor Department, have been shooting higher. In August, consumer prices were up 8.3% year-over-year.

So it might seem odd that a respected voice on Wall Street has since last year consistently warned that deflation – falling prices – is the bigger threat.

Cathie Wood, who heads the ArkInvest hedge fund, is sticking to her guns even as prices rise. Now, some other investors are starting to see it her way too. In recent days Tesla CEO Elon Musk and Jeffrey Gundlach, CEO of Doubleline Capital, have echoed her comments.

In a nutshell, here’s Wood’s hypothesis: Prices are rising now because of problems with supply. There still aren’t enough new cars, for example. But long term, she says that’s not a lasting trend.

Wood’s hedge fund invests mostly in growing technology “disruptors,” companies that shake up existing industries, like the way streaming is eating away at the cable industry. As these companies continue to grow, and as artificial intelligence (AI) is brought on line, Wood says the deflationary trend that actually began more than two decades ago, will pick right up again.

A mistake?

Wood -- and now Musk and Gundlach -- argue the Federal Reserve is making a huge mistake by continuing to hike interest rates to reduce inflation. All three worry that policy will throw the U.S. economy into a recession, reducing consumer demand precisely at the point when prices begin to fall.

“We are getting some loud voices now accompanying us on this deflation risk,” Wood said at an investor event this week. 

Musk and Gundlach have also been speaking out. Musk tweeted that the Fed should lower its key interest rate by 0.25% instead of raising it, noting that commodity prices, such as lumber and copper are well below their recent highs.

An economist weighs in

At least one economist has also joined the chorus. Writing in Politico, David Blanchflower, an economics professor at Dartmouth College, says the current Fed policy is “guessenomics, based on zero data.”

“More plausibly this path (of continuing to raise interest rates) leads to a hard landing with rising joblessness and an unnecessarily destructive economic recession,” Blanchflower writes and goes on to call for the Fed to cut, not raise interest rates. 

Fed policymakers meet next week and are expected to announce another rate hike of at least 0.75%, taking the effective federal funds rate to between 2.75% to 3%. An increase in the federal funds rate usually results in higher consumer rates on credit cards and auto loans.

The Fed’s money-tightening policy is one reason stocks – especially companies that are growing but not yet profitable – have suffered in recent months. Any sign that the Fed is considering a reversal of its present policy is likely to send the market higher.

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