Inflation Vs. Deflation – Which Is The Bigger Threat In 2022?

The Financial Times recently had a great piece on Central Bankers and their stance that inflationary pressures remain transient. However, as FT concluded:

“For the first time in many decades, there is the possibility that a significant turning point has arrived, that price rises will be more than a flash in the pan and something more difficult to control.”

It is interesting to hear statements such as the above because inflation has been rising steadily since 1974. The chart below shows the long-term history of inflation going back to 1774.

Inflation vs. Deflation, Inflation vs. Deflation – Which Is The Bigger Threat In 2022?

What the chart shows is that in 1954 the trajectory of inflation changed. However, the annual rate of change indicates the long-term deflationary trend.

Inflation vs. Deflation, Inflation vs. Deflation – Which Is The Bigger Threat In 2022?

Notably, before 1920 the economy was primarily agriculturally based with a dramatically smaller population. Such gave rise to more variability in economic growth. However, the shift to manufacturing and industrialization minimized the big deflationary swings before WWII.

Unfortunately, beginning in 1980, the economy made a shift to financialization and services. While service jobs have a low multiplier effect economically, economic financialization led to a debt explosion. As a result, the combination of debt and lower economic output remains a consistent deflationary pressure.

The Inflation Vs. Deflation Conundrum

Currently, the mainstream consensus has latched on the sharp increase in the money supply because a permanent shift to higher inflation is coming. Such was a point we discussed in “Is Hyperinflation A Threat?”

“The measure of money in the system, known as M2, is skyrocketing, which certainly supports that concern. Now, with the Biden administration adding another $1.9 trillion into the economy, those concerns have risen.”

Furthermore, in a previous Bloomberg interview, Larry Summers stated:

“There is a chance that macroeconomic stimulus on a scale closer to World War II levels will set off inflationary pressures of a kind not seen in a generation. I worry that containing an inflationary outbreak without triggering a recession could be even more difficult now than in the past.”

The chart below suggests those points are correct. Given it takes about 9-months for increases in money supply to hit the economy, we see the inflationary spike.

Inflation vs. Deflation, Inflation vs. Deflation – Which Is The Bigger Threat In 2022?

The sharp decline in money supply suggests deflationary impulses in the economy will become visible around the middle of 2022. Which is roughly when the Federal Reserve plans to hike interest rates. This is significant in the debate of inflation vs. deflation.

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