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September 6, 2026
Lacy Hunt, who for decades has been the best-known proponent of the deflationary thesis, now sees inflation as the greater risk in the coming years. In his view, a shortage of capital, the end of globalization, and spiraling government deficits point to structurally higher prices and interest rates. We analyze his argument—and highlight where we would assign at least as much weight to another factor.
Lacy Hunt's About-Face: Why "Dr. Deflation" Is Now Warning of Inflation
When an economist who has been regarded as a proponent of the deflationary thesis throughout his entire career publicly changes his mind, it’s worth listening closely. Lacy Hunt, chief economist at Hoisington Investment Management and former senior economist at the Federal Reserve, has done just that in his latest quarterly letter.
Hunt’s thesis can be attributed to a two-pronged structural challenge: a shortage of capital on the one hand, and the end of the three-decade-long phase of globalization on the other. The U.S. net savings rate—that is, the total amount effectively set aside by households, businesses, the government, and foreign entities—is close to zero, a level previously reached only in 1929 and during the financial crisis. At the same time, the demand for capital for physical investments is skyrocketing: the development of AI infrastructure, the expansion of semiconductor capacity, the long-overdue expansion of the power grid, plus space programs and a growing federal deficit. When such high investment needs meet such scarce savings, real interest rates must rise, according to Hunt’s interpretation—a simple but uncomfortable economic relationship.
The second pillar of his argument is the reversal of globalization. The disinflationary tailwind of the past decades stemmed from the entry of hundreds of millions of workers into the global production process following the end of the Cold War, amplified by enormous economies of scale. Today, the tide is turning: resilience takes precedence over efficiency, “just-in-case” replaces “just-in-time,” and supply chains are being relocated or distributed among friendly nations—a structurally more expensive approach, regardless of one’s political stance on the matter. Even artificial intelligence, which many see as a source of disinflationary productivity gains, is, in Hunt’s assessment, initially having the opposite effect: Building the necessary infrastructure consumes energy, capital, and network capacity, while any potential productivity gains—if they occur on this scale at all—would not materialize until later in the cycle.
Hunt is blunt about the fiscal situation. The estimate for the current U.S. budget deficit jumped within ten days from about 1.7 to 1.8 trillion to 2.1 trillion dollars—from 5.8 to 6.4 percent of GDP. The reason: The government wants to spend more on defense, the opposition wants to spend more on social programs, and historically, Washington rarely resolves such conflicting priorities through compromise, but rather by pursuing both at the same time. The federal debt is approaching 120 percent of GDP and is on track to reach 130 percent. Hunt quotes economic historian Niall Ferguson, who argues that great empires begin to decline as soon as their interest payments exceed defense spending—a threshold that, in his assessment, the U.S. is approaching.
Hunt also has nothing good to say about the Fed’s most recent monetary policy. Since December, the Fed has purchased about $1.5 trillion in government bonds through “quiet easing,” while bank balance sheets have expanded significantly and the velocity of money (M2) has risen from 1.1 to 1.4—which, in his view, is clearly inflationary. He is particularly critical of the recent intervention by Treasury Secretary Scott Bessent, who aims to suppress yields at the long end of the curve by purchasing additional long-term bonds. For Hunt, this is a “gimmick” that contradicts the stated goal of new Fed Chair Kevin Warsh to allow the market to send an unadulterated signal. His conclusion: The bond market is ultimately more powerful than any Treasury Secretary.
His analytical framework is based on the Fisher equation, according to which the nominal bond yield is composed of the real interest rate, expected inflation, and a risk premium. According to Hunt, all three components are trending upward: the real interest rate due to a shortage of capital; inflation expectations because money supply growth, at around 7.5 percent per year, is significantly above the optimal rule of 4 to 4.5 percent postulated by Milton Friedman —a rule based on declining potential growth due to weak demographics—and the risk premium because of the political inability to get the deficit under control. A side effect that Hunt specifically highlights: Higher interest rates disproportionately benefit the top two income deciles, which have savings, while harming the bottom eight deciles, which rely on credit—a distributional effect that further widens the K-shaped divergence in the economy.
For investors, Hunt draws a clear, if uncomfortable, conclusion: In a structurally inflationary environment with rising interest rates, it is difficult to be optimistic about bonds. Tangible assets and precious metals, whose intrinsic value cannot be easily disregarded, are likely to perform better in relative terms. As for the dollar, he expects it to remain weak in the short term, with no other currency ready to take its place—more of a seesaw than a clear trend in one direction.
Brent Johnson, known as the creator of the “dollar milkshake thesis,” largely agrees with Hunt’s analysis. It is worth adding here whether higher interest rates might not also have a stimulating effect, since interest payments do flow back into the economy—Hunt refers in this regard to the regressive distributional effect already mentioned. Johnson’s thesis also argues that the major technology conglomerates, with their enormous—and in some cases debt-financed—investments in AI infrastructure (around $800 billion this year alone), are effectively crowding the government out of the bond market and thereby driving up yields —a reversal of the classic “crowding-out” argument. For Hunt, however, it is clear whether Bessent’s current bond purchases serve bank balance sheets rather than government financing: The average maturity of government bonds held by banks is less than five years; banks are simply not buyers of long-term securities. Johnson, however, unlike Hunt, takes a more dollar-friendly view.
The investment strategy does not rely solely on theories
As persuasive as Hunt’s argument may be, we should not underestimate a counterforce that is only touched upon briefly in this discussion: the interplay between technological revolution and demographics. Hunt himself classifies weakening demographics—a stagnant or shrinking labor force—as inflationary, because they limit potential growth and thus the supply of labor. Historically, however, the opposite has been true: aging, shrinking societies—Japan being the textbook example of the past three decades—tend toward weak demand, subdued consumption, and thus disinflation or even deflation, not upward price pressure. Combined with a wave of AI and automation—which, contrary to Hunt’s description for the short term, could in the medium term deliver precisely the productivity gains that previous technological leaps have also brought—a renewed disinflationary or even deflationary phase would come as no surprise to us.
The key caveat, however, may also lie in the political arena. Since the COVID-19 pandemic, governments have had at their disposal a tool they had scarcely used before: direct fiscal stimulus—money that is pumped directly into the real economy via transfer payments, rather than merely seeping through the balance sheets of central banks as part of monetary policy. Lacy Hunt himself cited this very tool as one of the reasons for his change of heart. This is similar to what Russell Napier had stated in 2020. Whether the natural disinflationary forces of technology and demographics take effect depends less on the economy itself than on whether policymakers exercise restraint in the future or whether fiscal stimulus becomes the new normal. With the Trump administration, this danger appears to have been averted for now, though it continues to surface on a smaller scale—such as with fuel subsidies in Spain—and when the next major crisis hits, we’ll learn more about it. It therefore makes sense to continue investing in assets with intrinsic value and to closely monitor interest rate developments.
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Thomas Dubach