Inflation or deflation?

Recent macroeconomic discussions have highlighted contrasting views on inflation trends, particularly in light of interviews featuring economists Lacey Hunter and Steve Hanke. Hunter is known for his deflationary outlook, while Hanke advocates for slowing inflation, offering analysis that challenges the prevailing narrative of persistent inflation. In a detailed conversation between investor Lawrence Lepard and host Adam Taggart on the Thoughtful Money platform, Lepard criticized these perspectives while outlining his own expectations for monetary policy, asset prices, and the economic cycle. To more fully understand these views, we need to review the current macroeconomic environment. The US economy faces challenges from high debt levels, trade tensions, and shifting monetary policy. The Federal Reserve's interest rate path, fiscal deficits, and global geopolitical factors are all shaping inflation expectations. Hunter and Hanke's views represent the cautious end of the spectrum, while Lepard emphasizes potential inflation risks. By examining these debates, we can better grasp economic uncertainty and provide guidance for future policymaking.

Criticisms of Hanke's Outlook for Slowing Inflation

Hank's view emphasizes slowing inflation, attributing it to factors such as the debt burden and reduced consumption following excessive borrowing. He points to historical examples, such as the 1929 stock market crash, in which the unwinding of debt led to deflation. However, Leppard questions the applicability of this framework in the current environment, arguing that central bank and government policy responses often counteract deflationary pressures through aggressive monetary expansion. This reflects the role of interventionism in modern economies, as opposed to the laissez-faire policies of history.

The core of the disagreement lies in the measurement of inflation. Hanke, relying on official Consumer Price Index (CPI) data, suggests that money supply (M2) growth of approximately 4.5% is insufficient to meet the Fed's 2% inflation target and that M2 needs to expand at a 6% rate to achieve sustained inflation. Leppard counters that the CPI underestimates true inflation, citing, for example, electricity price increases exceeding 3% per year. He argues that M2 growth itself is a core driver of inflation, with uneven performance across different sectors, including asset price inflation during the low interest rate period following the 2008 Global Financial Crisis (GFC). This disagreement highlights a broader debate over monetary indicators. Historical data shows that M2 has averaged 7% growth over 50 years, consistent with long-term inflation trends, but short-term fluctuations—such as a 4.7% contraction after a 9% peak during the COVID-19 pandemic—complicate forecasting. Leppard's analysis suggests that accepting official indicators at face value ignores structural biases and can lead to underestimation of inflation risks. For example, asset inflation, such as stock and real estate bubbles, is underrepresented in the standard CPI, yet it significantly impacts wealth distribution and economic stability. Expanding on this point, we can examine the historical evolution of monetary theory. From Milton Friedman's monetarist perspective, money supply is the primary determinant of inflation. Hanke, as a monetarist, appears to agree to some extent, but his focus is more on short-term adjustments. In contrast, Leppard adopts a more strictly monetarist approach, emphasizing asset inflation channels. These channels were evident in the quantitative easing of the 2010s, which led to a stock market boom but muted consumer inflation. This suggests that inflation may be shifting from commodities to assets, challenging the validity of traditional indicators. Furthermore, the current global environment presents increased complexity. Supply chain disruptions, geopolitical tensions (such as the Russia-Ukraine conflict), and the energy transition are all driving up costs. These factors could amplify Leppard's concerns that official data fail to capture true economic pressures, thereby misleading policymakers. Disagreements and Concordances with Hunt's Deflationary Thesis Hunt's deflationary outlook is more pronounced, predicting lower prices due to fiscal dynamics and external shocks. He argues that the U.S. fiscal position is more balanced than generally believed and criticizes the Congressional Budget Office for accounting errors in its projections for recent legislation, such as the Big Beautiful Act. Hunt's estimate of tariff revenue exceeding $300 billion, which could offset the deficit, reflects an optimistic assessment of trade policy. Leppard challenged this optimism, noting that recent tariff collections have been around $20 billion per month, or $240 billion annualized—less than Hunter's projections. He highlighted the bill's potential additional spending, estimated at $200 billion to $600 billion, and warned that a slowing economy could worsen deficits by reducing revenues and increasing safety net costs, as seen in the 6-8% of GDP deficit increases in 2008 and 2000. Such fiscal deterioration could amplify cyclical risks, leading to a deeper recession. However, Leppard agreed with Hunter's reference to the Kindleberger spiral, referencing historical tariffs from the 1930s, such as the Smoot-Hawley tariffs, which averaged 19.7%—similar to the current U.S. level of 18%. Tariffs, acting as taxes, reduce demand, the trade deficit, and foreign investment in the US market, potentially leading to deflationary pressures. A weaker dollar could further deter foreign capital as currency losses offset asset gains. This is already evident in the current market, with a slowdown in foreign capital inflows. This section consistently reveals a nuanced perspective: while tariffs could induce short-term deflation, Leppard emphasizes the likely policy response—aggressive monetary easing—to prevent a systemic collapse. Hunter's call for a 100 basis point interest rate cut aligns with this, although Leppard notes the "fiscal emergency" faced by the Federal Reserve in its restrictive stance amid rising interest rate costs. This highlights a policy dilemma: short-term stability versus long-term sustainability. To further this analysis, the Kindleberger spiral, derived from the work of Charles Kindleberger, describes how financial crises are amplified through feedback loops. Applied today, tariffs could trigger a demand contraction, leading to reduced global trade and investment outflows. This is similar to the Great Depression, when protectionism exacerbated the economic downturn. Leppard added that a depreciating dollar could amplify these effects, as foreign investors face exchange rate risk, further weakening market liquidity. There is agreement on recognizing structural risks, but disagreement on policy flexibility. History shows that central bank interventions, such as the Federal Reserve's quantitative easing in 2008, often reverse deflationary trends and shift toward reflation. This could happen again in the current cycle, especially in an era of fiscal dominance. Broader Implications: Inflation, the Fourth Turning, and Asset Strategies The discussion expands to the longer-term cycle, framing the current era as the "Fourth Turning" (2008-2038), characterized by institutional turmoil and a potential monetary reset. Leppard anticipates a major inflationary event within three years, driven by fiscal dominance, with money printing covering interest payments. Historical parallels, such as post-World War II yield curve control leading to inflation peaks of 17-21%, support this outlook. This reminds us that the historical lessons of monetary policy are often ignored, leading to repetitive cycles. Energy costs have become a key inflationary driver, with US electricity prices rising due to AI-driven demand. This could elevate energy to a de facto constraint on growth, similar to oil prices before the shale boom, potentially overshadowing the Federal Reserve's funds rate. A policy shift toward nuclear and natural gas expansion could alleviate this, but delays risk continued price pressure. For example, China's leading position in nuclear energy investment highlights the United States' lag, and without acceleration, it could lose its competitive advantage. Regarding asset allocation, Leppard advocates for sound money alternatives: gold, silver, and Bitcoin. Gold and silver have broken through key resistance levels ($3,500 for gold and over $40 for silver), signaling a breakout from their current resistance levels. Bitcoin, considered digitally scarce with a fixed supply of 21 million, is projected to reach $140,000 by year-end and $1 million by 2030, outperforming due to its adoption curve. Mining companies remain undervalued relative to metals, trading at low cash flow multiples and offering further growth potential. By contrast, equities appear overvalued, although commodity-related and international stocks offer opportunities. Leppard cautions against allocating zero to sound money assets, recommending a 10-30% allocation to protect against devaluation. This is particularly important in volatile markets, where diversification mitigates risk. Expanding on this section, the concept of the Fourth Turning, derived from the work of William Strauss and Neil Howe, describes social cycles that occur every 80-100 years, encompassing phases of climax, awakening, deconstruction, and crisis. The current crisis phase involves a debt crisis and social divisions, potentially culminating in monetary reform. Leppard cites historical resets, such as Roosevelt's 1933 gold repricing, as a way to combat deflation. This could play out in the modern era, enhanced by digital assets like Bitcoin. Among asset strategies, Bitcoin is unique in its fixed supply, contrasting with gold's 1-2% annual growth. This supports its potential as a hedge, particularly in the digital economy. The valuation dynamics of mining stocks reflect leverage: rising metal prices amplify profits but also increase volatility. Investors should consider diversification to mitigate risk and monitor global trends such as central bank gold purchases. Conclusion: While Hunter and Hanke's interviews illuminate the deflationary risks of debt, tariffs, and fiscal pressure, Leppard's analysis highlights the counter-inflationary power of policy intervention. This tension suggests a volatile path: potential short-term inflationary slowdown or deflation in an economic slowdown, followed by aggressive money printing in a "big money printing" scenario. Faced with the potential underperformance of traditional assets, investors are favoring diversified exposure to real assets such as precious metals and cryptocurrencies. Ultimately, resolving these dynamics may require structural reforms, such as a return to sound money principles, to stabilize the system amid ongoing monetary challenges. To delve deeper, we can consider potential scenarios. If deflation prevails, bonds may benefit from a safe flight to safety, but the policy response could lead to yield curve control, similar to that of the 1940s. This could trigger a repricing of assets, favoring liquid assets. Conversely, if inflation accelerates, commodities and hard assets will become the preferred option. Policymakers face a dilemma: balancing growth and stability. The Fed's dovish shift could exacerbate inflationary pressures in the future. Investors should remain vigilant; education and diversification are key to navigating these times.