ARK, one of the world’s leading investment firms, has extended an open letter to the Federal Reserve (the Fed). In this letter, they address their concerns about deflation with rising interest rates.
In the letter, ARK says that “Without question, food and energy prices are important, but we do not believe that the Fed should be fighting and exacerbating the global pain associated with a supply shock to agriculture and energy commodities caused by Russia’s invasion of Ukraine.”
Ark Invest’s Cathie Wood’s primary concerns are a deflationary bust. In this article, we will detail exactly what this means. We will also discuss what we can do to better position ourselves from a personal finance perspective.
What is a Deflationary Bust?
Inflation is when the prices of goods and services rise, while deflation is when those prices fall. A deflationary bust happens when there is a significant drop in prices across the economy. The cause of this can be due to multiple factors. Some of these include a decrease in demand or an increase in supply.
When deflationary forces are at work, it becomes very difficult for businesses, particularly small businesses, to make a profit. This is because their costs remain the same. However, the prices they can charge for their goods and services keep falling. As a result, many businesses may have to lay off workers or even go out of business entirely.
Deflation can also lead to a decrease in wages as employers try to cut costs. This further reduces the amount of money people have to spend. Unfortunately, this can lead to a downward spiral in the economy.
What Causes Deflationary Busts?
Several different factors can cause deflationary busts. One common cause is a decrease in demand. This can happen when people lose their jobs and have less money to spend. It can also happen when people become more worried about the future and start saving more money instead of spending it.
Another common cause of deflationary busts is an increase in supply. This can happen when a new technology makes it cheaper to produce goods and services. Another cause can be when a country starts exporting more than it imports.
For example, Ark Invest’s open letter has explained, “Nike’s inventories increased 44.2% globally”. Despite sales growth of 3.6%, Nike may have to begin discounting to clear excess inventory. If Nike did this, then one could expect deflation in the footwear market.
The open letter from Ark Invest outlines several industries where similar statistics are shown to persist over the past few months.
Ark Invest has blamed the Fed’s dramatic increase in interest rates for this increased risk. “Could it be that the unprecedented 13-fold increase in interest rates during the last six months––likely 16-fold come November 2––has shocked not just the US but the world and raised the risks of a deflationary bust?”
The Problem With Raising Interest Rates Too Quickly
Although the Feds’ attempts to raise interest rates at a fast rate may be a noble attempt to combat inflation, it may have unintentionally caused a deflationary bust. This administrations Inflation Reduction Act certainly isn’t helping either. Raising interest rates too quickly can lead to a decrease in demand and an increase in supply in several different ways.
First, raising interest rates can lead to a decrease in demand because it makes borrowing money more expensive. This can cause people to spend less money and save more.
It can also cause businesses to invest less, which can lead to layoffs and a decrease in wages. Worst case scenario is that economies slow down or even go into a recession.
Second, raising interest rates can lead to an increase in supply. This is because when interest rates go up, the value of the dollar increases. As less money enters into circulation due to a disincentive to borrow due to the higher cost of debt, the value of each dollar increases.
This can be problematic because the value of the dollar may begin to seem more valuable than the goods and services which can cause business activity to decline.
Finally, raising interest rates too quickly can lead to a decrease in confidence. This is because when interest rates go up too fast, it can signal that the economy is not doing well.
Increasing interest rates is often done to combat inflation (which is a declining currency value). This can lead to people becoming more worried about the future and less likely to spend or invest.
All of these factors can lead to a decrease in demand, an increase in supply, and a decrease in confidence. These factors can all contribute to a deflationary bust, which would lead to a decrease in prices and a decrease in wages.
The open letter from Ark Invest argues that the Fed’s recent actions may have unintentionally caused a deflationary bust. This excessive money printing and a dramatic interest rate increase has not been seen before and could have unforeseen consequences.
What Can We Do From a Personal Finance Perspective?
Although the situation may seem dire, there are things that we can do from a personal finance perspective to protect ourselves.
First and foremost, we need to be aware of the risk of deflation and the potential for a deflationary bust. We need to prepare for the possibility that prices could start falling and that wages could decrease.
This means having an emergency fund that can cover our expenses for some time. In addition to this, it is also important to have a plan for how one would make ends meet if our income decreased.
Having a side hustle or improving upon your professional skills to ensure that you are employable during a downturn can be beneficial.
Second, we need to diversify your portfolio. This means having a mix of investments that will perform differently in different economic conditions. In Ark’s open letter to the Fed, the firm has outlined that many commodities have decreased in price.
If you’ve been keen on investing in commodities recently, you may be able to own precious metals and other commodities at a lower price as commodity price decreases are leading indicators of deflationary busts.
It remains to be seen whether the Fed will take heed of ARK’s advice, but given the risks of deflation, it is certainly something worth paying attention to. For more information on ARK’s investment strategy and their thoughts on the economy, be sure to check out their website or follow them on Twitter.
We also went into detail about the career of Cathie Wood (Founder of ARK Invest). Make sure to check out that article to learn more about her. This article details how she rose to be one of the most successful investors in recent memory.