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Could Inflation Turn into Disinflation and Deflation?
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Could Inflation Turn into Disinflation and Deflation?

Inflation could eventually turn into disinflation and deflation, according to Cathie Wood.

In a series of tweets posted early Monday morning, the Ark Investment Management founder disagrees with Jack Dorsey‘s view that U.S. inflation is heading to hyperinflation, meaning that inflation is spinning out of control.

On Friday evening, the co-founder and CEO of Twitter (TWTR) and the founder and CEO of Square (SQ) argued that “hyperinflation is going to change everything. It’s happening.” 

Wood thinks the opposite is the case: inflation could eventually turn to disinflation and deflation, a situation of inflation declining and finally falling below zero.

One of Wood’s tweets read:

“Now we believe that three sources of deflation will overcome the supply chain-induced inflation that is wreaking havoc on the global economy. Two sources are secular, or long term, and one is cyclical. Technologically enabled innovation is deflationary and the most potent source.”

3 Forces of Deflation, Explained

At the core of Wood’s deflation thesis are technological innovations, like Artificial Intelligence (AI) which raise productivity and drive production costs and prices lower.

“When costs and prices decline, velocity and disinflation — if not deflation — follow,” Wood said in another tweet. “If consumers and businesses believe that prices will fall in the future, they will wait to buy goods and services, pushing the velocity of money down.”

Another driver of deflation is financial engineering, the issuing of debt by American corporations to “enhance” shareholder values.

“They leveraged their balance sheets to pay dividends and buy back shares, “manufacturing” earnings per share,” Wood explained. “They have not invested enough in innovation and probably will be forced to service their debts by selling increasingly obsolete goods at discounts: deflation.”

Then there’s overstocking by some companies anxious to have enough inventories for the holiday season.

“As a result, once the holiday season passes and companies face excess supplies, prices should unwind,” Wood added. “Some commodity prices — lumber and iron ore — already have dropped 50%, China’s crackdowns are one of the reasons. The oil price is an outlier and psychologically important.” That’s deflationary, too.

Additional Sources of Deflation

Adding to Wood’s deflationary argument is excess capacity. According to the Federal Reserve Bank of Saint Louis, America’s capacity utilization is hovering around 75%, far below 85%, considered full capacity.

That’s a big difference between today’s economy and the economy of the 1970s, when inflation spun out of control.

Meanwhile, a couple of factors that kept consumer demand high even in the middle of the pandemic — like the generous government benefits and the Fed’s bond-buying program — have either expired, or are about to expire in the next 12 months.

Bottom Line

The U.S. economy can head in either direction on the inflation front, depending on which forces influence prices prevail.

Disclosure: At the time of publication, Panos Mourdoukoutas owned shares of Twitter and Square.

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