(Kitco News) The Federal Reserve ignores deflationary signals in the economy. And its hefty rate hikes could push the economy into something akin to the Great Depression, said Ark Invest CEO Cathie Wood.
Deflation signals are already strong and the pattern resembles that of the Roaring Twenties a hundred years ago.
“Before the Roaring Twenties, the world was at war – World War I – and suffered from a pandemic – the Spanish Flu. Although the two had a more severe impact on the global economy, today’s combination today is a powerful echo that could lead to much lower than expected inflation and a boom in innovation,” Wood said in a Twitter thread. “The setup is remarkably similar [to today]!”
The 1920s was the time when “several general-purpose technologies evolved at the same time,” including the telephone, electricity, and the internal combustion engine, Wood pointed out.
If inflation slows, as we think, then we could go back to the future, the Roaring Twenties, the last time several versatile technologies evolved at once: the telephone, electricity and the internal combustion engine. The setup is remarkably similar!
— Cathie Wood (@CathieDWood) November 12, 2022
Inflation in 1920 was over 20% when World War I and the Spanish flu triggered supply chain problems. In response, the Fed raised rates aggressively from 4.6% to 7% in just one year. In 1921, inflation fell to minus 15%.
Based on this example, Wood is not ruling out annual inflation turning negative in 2023 as the Fed continues to advance its hawkish monetary policy, which Wood described as a grave mistake.
“We wouldn’t be surprised to see headline inflation turn negative in 2023,” she wrote over the weekend. “The Fed less than doubled interest rates from 4.6% to 7% in 1919-20. Faced with much lower inflation this time around, the Fed raised interest rates 16 times , a serious mistake in our view.”
However, there is a window of opportunity to revisit the Roaring Twenties, and that will depend on what the Fed decides to do next year.
“If inflation falls below the Fed’s 2% target and economic activity disappoints, then interest rates will likely surprise on the low side of expectations next year, ushering in the interpretation of this century of the Roaring Twenties,” Wood explained.
When inflation fell to minus 15% in June 1921, the Fed cut rates from 7% to 4% within 14 months. This “trip[ed] the switch for the Roaring Twenties,” Wood said.
Wood warned that with the Fed now solely focused on fighting inflation, a 2023 Fed pivot may not happen, which could lead to something akin to the Great Depression.
“If the Fed doesn’t pivot, the setup will look more like 1929. The Fed raised rates in 1929 to stifle financial speculation, then in 1930 Congress passed Smoot-Hawley, imposing tariffs of more than 50% on over 20,000 goods and pushing the global economy into the Great Depression,” she noted.
So far, the US central bank has ignored deflationary signals, with Fed officials not even discussing their current monetary policy program, with all members voting unanimously.
“The Fed ignores deflationary signals, and the Chips Act could hurt trade perhaps more than we realize. Much like the reaction to Smoot-Harley, economists have paid little attention to the potential impact of the Chips Act,” she added. “The University of Michigan consumer sentiment survey is at an all-time high, below levels reached in 2008-09 and 1979-82, a setup for a liquidity trap like the Great Depression when the massive monetary stimulus has failed.”
The CHIPS and Science Act took effect on August 9, 2022. Its goal is to invest $280 billion to boost US competitiveness, innovation, and national security. Targeted industries include domestic semiconductor manufacturing capacity, quantum computing, AI, clean energy and nanotechnology.
Wood isn’t the only voice in the deflation camp, with DoubleLine CEO Jeffrey Gundlach recently stating that the risk of deflation is much higher today than it has been for the past two years.
Over the weekend, Goldman Sachs also downgraded its inflation outlook, noting that it expects a “significant” easing in price pressures in the United States in 2023. The bank cited a spike in housing inflation, slower wage growth and easing supply chain issues.
In its updated estimate, core personal consumption expenditure (PCE), which is the Fed’s preferred measure of inflation, is expected to slow to 2.9% by December 2023. Currently, core PCE stands at 5.1%.
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