Inflation is without comparison the word of the year 2022.
The rising prices of goods and services are at their highest level in 40 years, which greatly affects the purchasing power of households.
To relieve consumers, the Federal Reserve has initiated an aggressive monetary policy, characterized by a sharp increase in interest rates. Economists warn that this monetary policy, which is also observed in other regions of the world, especially in Europe with the European Central Bank, risks causing a so-called “hard landing” for the US economy. Basically, if the Fed continues to be so aggressive in its monetary tightening, it risks causing a recession.
While many companies have passed on their rising costs to consumers by raising the prices of their products, many companies have also started laying off employees. Alphabet (GOOGLE) the parent company of internet giant Google, has just warned that the company is likely to make layoffs in the near future in order to be 20% more efficient than it is today.
“The more we try to understand the macro economy, we feel very uncertain about it,” CEO Sundar Pichai said at the 2022 annual Code conference in Los Angeles on September 6. “Macroeconomic performance is correlated to advertising spending, consumer spending, and so on.”
Fed can cause deflation
But despite the warnings, the Fed has decided to continue its fight against inflation. In his final public remarks before the Sept. 21 policy meeting, Fed Chairman Jerome Powell essentially cemented the case for a third consecutive 75 basis point rate hike.
“We need to act now, right up front, strongly as we have, and we need to keep doing it until the job is done,” Powell said on Sept. 8. “The Fed has and accepts responsibility for price stability.”
CME Group’s FedWatch prices an 86% chance of a 75 basis point rate hike, the third in a row, as investors look for a so-called ‘terminal’ Fed Funds rate north of 4% before Powell signals a pause in monetary policy tightening.
Elon Musk, the richest man in the world, believes that if the Fed continues, as is now expected by the markets, with a jumbo rate hike, the institution will cause deflation. In short, most goods and services will be ridiculously cheap.
“A major Fed rate hike risks deflation,” said the CEO of EV maker Tesla (TSLA) on Twitter on September 9.
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He did not provide further details.
Musk’s tweet provoked many reactions, including Europac chief economist and global strategist Peter Schiff. The latter does not agree with the serial entrepreneur and rather believes that it will be the opposite. For Schiff, a major rate hike by the Fed could cause “hyperinflation” and a “severe recession.” He added that it could “produce a worse financial crisis than 2008.”
“It risks #hyperinflation. Higher debt servicing costs, a severe #recession, exploding federal budget deficits and collapsing asset prices will produce a financial crisis worse than 2008. #Fed will respond with massive QE [quantitative easing]tanks the dollar and sends consumer prices soaring,” Schiff said.
Musk and Deflation
Deflation is defined as the opposite of inflation. It is characterized by a continuous fall in the general price level. That could encourage households to postpone their purchase decisions while they wait for further price declines and, above all, cause a worsening of borrowers’ financial situation, economists say.
The consequences can be devastating for the economy because the regular price drop encourages households to postpone their purchase decisions while they wait for further price drops. This behavior can lead to a decrease in overall consumption and an increase in the inventories of companies that can no longer sell their products. In response, they reduce their production and their investment.
Deflation can be caused by greater productivity or less demand.
Cases of deflation are rare in rich countries. There are only two examples of this over the past century: the deflation of the 1930s, which affected the United States and then Europe, and the one that affected the Japanese economy in the late 1990s.
This is not the first time Musk has predicted an era of lower prices. Last April, the billionaire had already predicted that we would soon enter a “world of abundance” where most things will cost nothing. But this deflation would not be due to a monetary decision, but rather due to major advances in artificial intelligence and robotics that will increasingly be used in our daily lives.
“This will truly be a world of abundance. All goods and services will be available to anyone who wants them. It will be so cheap to have goods and services, it will be ridiculous,” said the billionaire during an interview with Chris Anderson, host of Ted Talks, on April 17.
He added that: “It will be a world of abundance. The only scarcity that will exist in the future is the one we decide to create as humans.”