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Inflation Head-Fake Ahead, but First, Financial Crisis & Deflation Lombardi Letter 2022-12-13 06:43:51 inflation Federal Reserve financial crisis Get ready for a massive inflation head-fake. While the inflation rate is expected to get under control in the coming quarters, don’t be shocked if, a few years down the road, we're looking at an inflation rate as high as 20%. Inflation

Inflation Head-Fake Ahead, but First, Financial Crisis & Deflation

Inflation - By |
Inflation head fake

Inflation Is Entrenched, but It Could Cool

Inflation is now a big problem; it’s entrenched. Be careful of what follows next. Inflation could do a head-fake, and hyperinflation could become a reality in the coming years.

As it stands, Americans are finding that their purchasing power has eroded significantly. Therefore, they’ve been watching their wallets, budgets, and everything else around their finances.


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Recently, the CEO of Walmart Inc (NYSE: WMT), Doug McMillon, said that American shoppers were feeling “stressed” about inflation. “We’ve got some customers who are more budget-conscious that have been under inflation pressure now for months.” He continued, “That sustained pressure in some categories, I think, is something customers are having to deal with as we approach Christmas.” (Source: “Walmart CEO Says Shoppers Are Being More Selective as They Deal With Inflation,” CNBC, December 6, 2022.)

While the comment from the Walmart CEO is worth noting, other companies have talked about similar problems. Moreover, consumer and business sentiment-related surveys and indicators have made it pretty clear that individuals and companies are worried about inflation.

What’s Next For Inflation?

Here’s the thing: to fight inflation, the Federal Reserve has come to the rescue. The Fed has been raising interest rates and has repeatedly said it won’t stop doing so until it sees inflation cool down. The hope is that raising interest rates will eventually hurt demand and ultimately have a downward impact on prices. This is Economics 101.

Demand destruction has already started. Consumers are pessimistic and their spending has started to wane a little.

Activity in the U.S. housing market has been stalling. Home sales and the demand for mortgages have been dropping. Home prices have been cooling a little. Car sales have been dropping and are well off their highs. Prices of commodities like oil and wholesale gasoline have come down as well. The cost of building materials had been adding more fuel to already hot inflation, but lumber prices are currently down by about 60% over the past year.

This is all great news, to say the least. With all this happening, it’s highly likely that the official measure of inflation will come down. Don’t forget that the Federal Reserve’s policies take several quarters to play out.

Now, the Real Problem

Dear reader, you have to ask what will happen as interest rates soar and there’s more demand destruction in the U.S. economy. You don’t have to be a rocket scientist to see what could follow: a severe recession.

An economic slowdown would bring down the official inflation rate. In fact, it wouldn’t be shocking to me if we even start flirting with a deflationary environment and financial crisis.

The problem: assuming we get slight hints of deflation ahead and a financial crisis brews, I anticipate that the Federal Reserve will go all out and start lowering interest rates and printing money as it did in response to the past few financial crises. In fact, in the coming crisis, the Fed might even take its benchmark rate below zero percent.

Sadly, this will start creating the same problems we had before inflation started to get out of control: more money in the system, insane risk-taking, soaring debt, and so on.

In the next little while, we’re going to see inflation cool off. Economics 101 suggests it will. But be ready for what follows next. Inflation could do a huge head-fake. If you thought an inflation rate of eight to nine percent was high, in the next round of inflationary pressures, we could see inflation of 15% to 20%. Scary.

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