Could we be heading back to the Roaring Twenties?

The Roaring Twenties was a period of economic prosperity with a distinctive cultural edge in major cities like Berlin, Buenas Aires, Chicago, London, Los Angeles, Mexico City, New York, Paris, and Sydney. We saw the large-scale development and use of new technologies like automobiles, telephones, films, radio, and electrical appliances. Aviation soon became a business. Nations saw rapid industrial growth and accelerated consumer demand.

On November 12, 2022, Cathie Wood, an American investor and founder of Ark Invest, a multi-billion dollar investment fund, tweeted the following: if inflation is unwinding, as we believe, then we could be heading back to the future, the Roaring Twenties, the last time several general purpose technologies evolved at the same time: telephone, electricity, and the internal combustion engine. The setup is remarkably similar. Cathie Wood is saying that we are seeing a similar convergence of technology in the form of blockchain, robotics, and artificial intelligence. So let's dig a little deeper into her tweet.

She says that prior to the Roaring Twenties, the world was at war (World War 1) and suffering a pandemic (the Spanish flu). While both had a more serious impact on the global economy, today's combination of war in Ukraine and COVID is a strong echo.

During World War I and the Spanish Flu, supply chain, and other shocks pushed inflation above 20 percent. At its worst in June 1920, inflation peaked at 24 percent but then dropped precipitously in one year to negative 15 percent in June 1921. We would not be surprised to see broad-based inflation turn negative in 2023.

Founded in 1913 and challenged by its first bout of serious inflation, the Fed raised interest rates less than two-fold from 4.6 percent to 7 percent from 1919 to 1920. Faced with much less inflation this time around, the Fed has increased interest rates 16-fold in 2022, a serious mistake in their opinion. If inflation drops below the Fed's 2 percent target, then interest rates are likely to surprise on the low side of expectations next year, ushering in this century's rendition of the Roaring Twenties.

As inflation dropped to negative 15 percent in June 2021, the Fed lowered interest rates from 7 percent in May 2021 to 4 percent in July 2022, tripping the switch for the Roaring Twenties. From August 2032 to September 2029, the Dow Jones Industrial Average compounded at an annual rate of 25 percent.

If the Fed does not pivot, the setup will be more like 1929. The Fed raised rates in 1929 to squelch financial speculation and then, in 1930, Congress passed Smoot-Hawley putting 50 percent + tariffs on more than 20,000 goods and pushing the global economy into the Global Recession.

Unfortunately, today has some echoes of the same. The Fed is ignoring deflationary signals, and the Chips Act (an act signed in 2022 to boost US competitiveness, innovation, and national security by catalyzing investments in the domestic semiconductor market) could harm trade perhaps more than we understand. Much like the reaction to the Smoot-Hawley, economists have paid little attention to the potential impact of the Chips Act.

The University of Michigan's Consumer Sentiment is at a record low, below levels hit in the 2008/2009 era. Clearly, we should be rooting against depression and we should be rooting for the Roaring Twenties. Given the conflicting data and the stark differences in these outcomes, the Fed should be debating the possible risks associated with its current policy.

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