Part of the fun of reading the legendary strategist Russell Napier is that we are reminded that we have so much more to learn about the world we live in. In this succinct piece for the FT he explains (once again) what he has been saying for the past ten years – now that the post-Lehman damage limitation job is done [in the form of QE] we are heading towards the collapse of the global monetary system.
The system we are living in at present, says Napier, was stitched together post mid-1990s Asian crisis wherein central banks implicitly agreed that they would keep their currencies weak by constantly buying US government bonds. This resulted in most countries other than America accumulating massive forex reserves and it allowed America to fund its burgeoning public debt at low yields. For equity investors around the world this created conditions in which they could make lots of money – growth was punchy thanks to weak currencies and the global cost of capital was low since US government bond yields were held in check. In effect, the rise in American public debt was funded by central banks in other countries thus freeing up American savings (and savings in other countries) to invest in the private sector.
Napier says that this party started coming to end from 2014 onwards as other central banks started cutting back on their purchases of US government bonds. “Foreign central banks ownership of US Treasuries has fallen from a third five years ago to just under a quarter today. Savers must take up the funding slack, while also buying Treasuries being sold by the Federal Reserve. This structural shift in the demand for Treasuries comes as supply is boosted by the Trump administration’s fiscal policy. Savers now have to fund the US government, and to do so they have to either sell other assets or save more. All the movements in asset prices over the past six months bear witness to the huge shift in savings under way, with negative implications ultimately for economic growth.”
Napier reckons things will get worse going forward. (1) Lower growth, lower inflation and higher cost of capital will lead to lower asset prices and lower cashflows. That in turn will create solvency issues since the global ratio of non-financial debt: GDP is 234% now vs 210% in Dec 2010. (2) China looks like it is heading for a train wreck as the “country’s debt:GDP ratio is rising at probably the fastest rate ever for a big economy is peacetime….the burden of the economic adjustment enforced by the end of the growth in its foreign exchange reserves, and hence money supply, will probably be deflationary and will involve debt default. China will probably move to a flexible exchange rate, thus creating the freedom to grow and inflate away these debts. It is that exchange-rate adjustment that will destroy the current global monetary system.”
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