Thread by @CathieDWood

In 2008-09, when the Fed started quantitative easing, I thought that inflation would take off. I was wrong. Instead, velocity - the rate at which money turns over per year - declined, taking away its inflationary sting. Velocity still is falling.

https://twitter.com/jack/status/1451733913961783299

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.

Artificial intelligence (AI) training costs, for example, are dropping 40-70% at an annual rate, a record-breaking deflationary force. AI is likely to transform every sector, industry, and company during the 5 to 10 years.

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

The second secular source of deflation could be creative destruction, thanks to disruptive innovation. Since the tech and telecom bust and the Global Financial Crisis in 2008-09, many companies have catered to short-term oriented shareholders who want profits/dividends now….

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

The third and most controversial source of deflation is cyclical. Because businesses shut down and were caught flat-footed as goods consumption took off during the coronavirus crisis, they still are scrambling to catch up, probably double- and triple-ordering beyond their needs.

As a result, once the holiday season passes and companies face excess supplies, prices should unwind. 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.

Oil has had three sources of support on the SUPPLY side. Global DEMAND for oil is below that in 2019 and is unlikely to return to its old high, partly because its price has broken a string of lower highs and is above the $77 hit in 2018, therefore destroying demand.

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On the supply side, ESG (environmental, social, and governance) mandates have forced energy companies to shift capital spending from mature fossil fuels to nascent renewables. Meanwhile, banks have deprived fracking companies of funding after their near-death experience in 2020.

In response to the near quadrupling of oil prices since the low last year, electric vehicle adoption has accelerated, sowing the seeds of a serious oil price decline longer term.

Truth always wins!