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In a week dominated by earnings and Halloween prep, inflation somehow stole the show.

It all started with an argument among tech moguls. On October 22, Twitter CEO Jack Dorsey tweeted, “Hyperinflation is going to change everything, it’s happening.” ARK founder Cathie Wood took the other side, saying that deflation is the bigger risk to the economy because of technological innovation and too much supply. Elon Musk chimed in, because of course he did.

All jokes aside, the tweets sent the internet into a frenzy with Google searches of “hyperinflation” surging. It didn’t help that the bond market’s inflation expectations rose to a 15-year high this week.

With inflation, it’s tough not to think about the worst-case scenario. The market seemingly believes we are past the point of the Fed’s “transitory” timeline with potentially no end in sight. And now, economists and talking heads are throwing around nefarious inflation terms (stagflation, anyone?).

Graph titled Inflation or Hyperinflation? tracks the 5-year breakeven rate between 2011 and 2021. Breakeven rates are the difference between nominal Treasury yields and TIPS yields of the same maturity. They show the market’s implied inflation expectations over a set number of years. From 2011 to mid-2014, the rate generally stayed between 1.5% and 2.5%. From mid-2014 through early 2020, the rate was generally between just below 1.0% and just over 2.0%. In early 2020, the rate plummeted to close to 0.0% before rocketing back up to nearly 2.5%. Source: Ally Invest, Bloomberg

Before you start taking sides, let’s talk about what these words actually mean.

Jack’s Side: Hyperinflation

Jack may have a point. Inflation is historically high. There’s no arguing that. Rising inflation could last a while, especially when wages start increasing. And if high inflation sticks around, it could eventually change how companies run and consumers shop.

What he’s missing: Declaring hyperinflation is a bold move. Inflation is when prices rise. But hyperinflation is when inflation spirals out of control. By one definition, hyperinflation is when inflation rises 50% or more in a month. This tends to happen when a currency collapses after a major crisis — like a war or political instability.

Hyperinflation is what we saw in the Weimar Republic of Germany after World War I or, more recently, in Venezuela during the country’s socioeconomic woes. We seem to be far away from that, based on global confidence in the U.S. The U.S. dollar is the world’s reserve currency, and there’s a strong base of international money flowing into domestic markets. Predicting hyperinflation is essentially calling for the collapse of the U.S. economy, not a pricier cup of coffee. And that may be a small risk at the moment.

Cathie’s Side: Deflation

Cathie’s argument may hold some water, too. In a vacuum, better technology can lead to more efficiency, which can ultimately drive prices down. And society could eventually be caught on the other side of the boat, with supply outweighing demand. If supply chain issues really are just pandemic-related quirks, they could subside soon.

What she’s missing: A return to normal isn’t the same as deflation. Deflation is when prices fall (instead of increasing at a slower rate), and it’s a rare occurrence that tends to happen around economic recessions. In fact, deflation, as measured by a month-over-month decline in the core Consumer Price Index (CPI), has only happened in six months since 1970. All were around economic crises when spending was depressed and manufacturing activity was low — the opposite of what’s happening today.

Chart titled Deflation Tends to Happen Around Recessions tracks month-over-month changes in the core Consumer Price Index (CPI) with recession periods highlighted from 2000 through 2021. The three deflationary months during that time were January 2010, April 2020 and May 2020. Periods of recession were in mid to late 2001, 2008 through mid-2009 and March 2020. Note that core CPI excludes food and gas prices. Source: Ally Invest, Bloomberg

Today, the inflation issue may be more a matter of demand outstripping supply than supply not keeping up with demand. We’d expect to see more warning signs about spending and confidence before seriously worrying about deflation.

Wall Street’s Side: Stagflation

Bonus round: Let’s talk about stagflation, the weird combination of low (to no) economic growth and strong inflation.

Stagflation has been the buzzword of Wall Street economists since the latest wave of COVID struck. It’s a doubly potent economic phenomenon of lower consumer confidence and higher prices. Economists point to the 1970s as a classic case of stagflation, when inflation spiked amid historic oil embargoes and the economy slipped into a 16-month recession.

It’s hard to stomach the fact that GDP growth slowed in the third quarter, even while inflation rose the most in 30 years. Maybe the stagflation-istas are on to something.

What they’re missing: We’re in 2021, not the 1970s. The world is different now. The Federal Reserve’s policy on interest rates is near zero (instead of 5 to 10% in the early 70s), and Fed officials are being mindful about the push and pull between growth and inflation.

There are signs of strong demand and confidence all around us, making it tough to justify the “stag” in stagflation. Plus, the job market is in much different shape now versus back then. In May 1974, unemployment spiked to 9% while core CPI grew 6.8% year over year the same month. Today, the unemployment rate has drifted below 5%, and the economy is in the unusual situation of having 1.2 job openings for every unemployed person. Productivity, or output per hour, is also increasing at an impressive rate, a trend that could support higher growth and lower costs in the years ahead.

The Bottom Line

It’s smart to think about the risks, and inflation is undeniably near the top of the market’s risk list. But in this age of social media and narratives, try not to fall into a bear trap. Pessimism has made for great stories, but it has also led to poor long-term portfolio returns over time. Try to zoom out and think equally about the positives and negatives, and don’t underestimate society’s ability to adapt and improve.

What Jack and Cathie won’t tell you is that U.S. inflation data has been remarkably steady, with year-over-year core CPI barely crossing 2% over the past decade (until this year). Chalk that up to demographic forces, international competition for goods, and — to Cathie’s point — technological innovation.

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Headshot of Callie CoxAs senior investment strategist for Ally Invest, Callie Cox helps educate Ally Invest customers about the financial markets through engaging content and strategic initiatives. Callie has worked in financial research for her entire career, with stints at LPL Research, TABB Group and Bloomberg. Her work has been featured in Bloomberg, the Financial Times, Yahoo Finance, and Barron’s (among other publications). You can also find her on Twitter at @callieabost.