Inflation is by far the word of the year 2022.
Soaring prices of goods and services are at their highest for 40 years, which considerably affects the purchasing power of households.
To relieve consumers, the Federal Reserve embarked on an aggressive monetary policy, marked by a sharp rise in interest rates. Economists warn that this monetary policy, also observed in other regions of the world, notably in Europe with the European Central Bank, risks causing a so-called “hard landing” for the American economy. Basically, if the Fed continues to be this aggressive in its monetary tightening, it risks triggering a recession.
As many companies passed on their rising costs to consumers by raising the prices of their products, many companies also began laying off workers. Alphabet (GOOGL) the parent company of internet giant Google, has just warned that the company will have to make layoffs in the near future to be 20% more efficient than it is today.
“The more we try to understand macroeconomics, the more we feel very uncertain about it,” CEO Sundar Pichai said at the 2022 Code Annual Conference in Los Angeles on Sept. 6. “Macroeconomic performance is correlated with advertising spending, consumer spending, etc. on.”
The Fed could cause deflation
But despite the warnings, the Fed decided to continue its fight against inflation. In his final public remarks ahead of the Sept. 21 policy meeting, Fed Chairman Jerome Powell essentially cemented the case for a third straight 75 basis point rate hike.
“We must act now, frankly, firmly as we have done, and we must continue until the job is done,” Powell said on September 8. “The Fed has and accepts responsibility for price stability.”
CME Group’s FedWatch puts the odds of a 75 basis point rate hike at 86%, the third in a row, as investors look for a so-called “terminal” federal funds rate that is north of 4% before than Powell signals a pause in monetary tightening.
Elon Musk, the richest man in the world, believes that if the Fed proceeds, as now expected by the markets, with a massive hike in interest rates, the institution will cause deflation. In short, most goods and services will be ridiculously cheap.
‘Major Fed rate hike risks deflation,’ electric vehicle maker Tesla CEO says (TSLA) on Twitter on September 9.
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He gave no further details.
Musk’s tweet drew many reactions, including one from Europac chief economist and global strategist Peter Schiff. The latter does not agree with the serial entrepreneur and rather thinks that it will be the opposite. For Schiff, a significant rate hike by the Fed could cause “hyperinflation” and a “severe recession”. He added that this could “produce a financial crisis worse than that of 2008”.
“This is likely to be #hyperinflation. Higher debt servicing costs, a severe #recession, exploding federal budget deficits and collapsing asset prices will produce a financial crisis worse than 2008. The # Fed will respond with massive QE [quantitative easing]causing the dollar to fall and consumer prices to skyrocket,” Schiff said.
Musk and deflation
Deflation is defined as the opposite of inflation. It is characterized by a continuous decline in the general level of prices. It can encourage households to postpone their purchasing decisions while waiting for further price cuts and, above all, cause a deterioration in the financial situation of borrowers, economists believe.
The consequences can be devastating for the economy as the steady decline in prices prompts households to put off their buying decisions while waiting for further price cuts. This behavior can lead to a drop in overall consumption and an increase in the stocks of companies that can no longer sell their products. In response, they reduce their production and investments.
Deflation can be caused by higher productivity or lower demand.
Cases of deflation are rare in rich countries. There are only two examples of this in the last century: the deflation of the 1930s, which hit the United States and then Europe, and that which hit the Japanese economy in the late 1990s.
This isn’t the first time Musk has predicted the era of falling prices. Last April, the billionaire had already predicted that we would soon enter a “world of abundance” during which most things will cost nothing. But this deflation would not be due to a monetary decision but rather to major advances in artificial intelligence and robotics which will be increasingly used in our daily lives.
“It will truly be a world of plenty. 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,” the billionaire said during an interview with Chris Anderson, head of Ted Talks, on April 17.
He added that: “It will be a world of plenty. The only scarcity that will exist in the future is the one we choose to create as humans.”