The soon-to-be-released Tesla (TSLA) Model X has a whopping $132,000 price tag. The current Model S P85D starts at $105,000; naturally the Tesla Model 3, priced at $35,000, is a steal... right? I mean, Musk has also given consumers the gift of a two-year pre-order window: not only is he a revolutionary, but he's also a philanthropist, or so the public has been led to believe...
Before this post is flagged for slanderous rhetoric, please allow me to explain my skepticism, which is actually unrelated to Musk and Tesla. In fact, the premise of this article pertains to a global economic slowdown, an indecisive Fed, and Janet Yellen. If anything, this is a tribute to Tesla's intelligent staff and PR team. So, without any further justifications, please allow me to explain the brilliance behind Tesla's recent Model 3 announcement, which is contingent upon four factors:
- The Federal Reserve's decision (or lack thereof) to hike interest rates.
- The Time Value of Money and current Purchasing Power effects.
- The possibility of future disinflation (a decrease in the rate of inflation) and, perhaps, even deflation (a widespread decrease in the prices of inelastic goods).
- Consumer preferences, based on behavioral tendencies (i.e. immediate gratification).
Let's begin with this game of "chicken" the Federal Reserve is playing with the U.S. economy. Sentiment is mixed on whether Janet Yellen will announce a .25% rate hike this Thursday (reports are as low as .15%) - this hasn't occurred in nearly a decade. Historically, U.S. dollar inflation has hovered around 2% (a Fed mandate). While current inflation rates are lower than historical averages, America's currency continues to lose long-term "real" value, which actually has a positive economic impact. For example, knowing that your dollar has less purchasing power tomorrow, than it does today, should encourage you to actively spend more at present (Time Value of Money). Given Tesla's Model 3 is currently priced at $35,000, and that inflation will increase this price by 2017, it's completely rational for consumers to spend $5,000 on a 2015 deposit. However, this assumption is based on the pretext that a Fed rate hike won't induce disinflation or deflation.
Why is this important? A Fed interest rate hike will naturally decrease America's money supply, as capital becomes more expensive to borrow. Consequently, inflation could fall (disinflation) as consumers become more price sensitive. Now, depending on the degree to which U.S. retail spending decreases (70% of our GDP), America's economic landscape could drastically change. Given current economic indicators, it appears the United States is finally recovering at an "acceptable" rate. Hence, so long as negative consumer and commercial speculation remains low, it's unlikely America will enter a deflationary state. However, global economic conditions remain a concern. If China and emerging markets continue to struggle, widespread speculation could overwhelm technical fundamentals and push America into a deflationary period. To be clear, Musk is betting his $33.8 billion company on the latter outcome.
For the sake of argument, let's assume a Fed rate hike does result in prolonged deflation. In this case, Musk comes out ahead of his competitors; his massive bet against inflation is the talk of all prominent Wall Street bankers. Why? Because under deflationary pressures, you may no longer wish to purchase a Model 3 sedan at the previously-agreed-upon price of $35,000. As such, Tesla generates $5,000 in pure profit from your early deposit. Conversely, if you do fulfill your order obligation, Tesla sells you its new sports car at a higher relative price. Moreover, because most consumers likely won't write off $5,000 as a sunk cost, Tesla will produce and sell more cars than its competitors (so as to fulfill 2015-2017 demand): otherwise known as music to shareholders' ears.