Lately, there has been a lot of talk about inflation in the media. Inflation is the general rise in the prices of goods and services over a period in an economy. Mild inflation is always good for the economy as it creates demand for products and increases wages. Federal Reserve always targets the official inflation to be at 2% to avoid the situations like hyperinflation and deflation. In short, too little inflation is bad. Too much inflation is also bad. In an ideal world, we want inflation at a certain level. Hyperinflation and Deflation Now that we are clear about what inflation is, let’s talk about the extreme. Hyperinflation occurs when the prices rise by 50% every month over a period. Hyperinflation negatively impacts the economy as it leads to a situation where money loses its value. People lost their purchasing power when hyperinflation occurred in the 1920s in Germany and 1970s in the United States. During the days of the Weimar Republic Germany (1918 to 1933), when inflation was at it’s worst, an apple could cost fifty cents one day, five dollars the next day, fifty dollars the day thereafter. Instability with the currency and rising inflation led to chaos and instability in the streets. During the 1970s, here in America, inflation skyrocketed, and there were long periods of time where there was little progress made in the Stock Market for years. On the opposite side of the spectrum, we have Deflation. Deflation occurs when the inflation rate falls below 0%. Deflation causes a general decrease in the prices of products and services over a prolonged period. Deflation can lead to a temporary financial crisis and unemployment. The United States experienced deflation between 1930 and 1933, an era of the Great Depression. Japan also experienced a mild deflation in the mid-1990s. We are still seeing the effects to this day. The inflation rate of the United States has gone down from 3.2% in 2011 to 1.2% in November 2020, indicating the possibility of deflation in the next five years. However, the situation had changed as the inflation rates increased from 1.4% in January 2021 to 5.4% in July 2021. Views of Cathie Wood on Inflation and Deflation Jerome Powell, the chairman of the Federal Reserve, stated that the recent increase in the inflation rate is transitory; it happened due to the supply chain bottlenecks and lower base effect. Cathie Wood, the CEO of ARK Investments, agreed with Jerome Powell and indicated that deflation is a big risk ahead over the next five years, not inflation. According to Cathie, the sources of deflation could be the innovation that creates an economic boom (good deflation), creative destruction of companies that fail to innovate (bad deflation), and falling commodity prices. The innovations like DNA sequencing, robotics, energy storage, and artificial intelligence can create good deflation and reduce the costs in every sector including healthcare, automobiles, energy, and retail. Organizations that fail to innovate will create bad deflation. Sectors like automobiles, energy, and financials would see a great impact of creative destruction. Electric vehicles and digital wallets are going to be the future; automobile companies that fail to bring in electric vehicles and financial institutions that don’t adapt to fast-changing digital technologies are likely to take a backseat in the competition. Cathie expects a fall in fuel prices in the first half of 2022. Since the fuel inventories are reaching their full capacities, the demand for fuel would reduce. The fall in fuel prices can also lead to market volatility. Recently, we saw inflation shoot up, then, it seemed to stabilize somewhat. As we write this, inflation is now hoovering around 5%. The cost of raw materials, like lumber, have tripled. Oil is at an all time high. Cost of consumer goods are getting higher. Some companies have decided to make smaller packaging and deliver the same products with less quantity size while keeping prices the same in order to stay competitive. Are consumers happy with their groceries shrinking while still paying the same at the cash register? Both hyperinflation and deflation can negatively influence an investment portfolio. An investor may not have an understanding of the macroeconomic factors that result in market volatility. Working with a good wealth management firm in Los Angeles may help high net worth individuals create a plan to protect their investment portfolios from rare economic conditions like hyperinflation and deflation. (*SOURCE: WSJ, CNBC)
