Russell Napier: We Are Entering a Time of Financial Repression
When it comes to stepping back and looking at the big picture through the lens of financial history to see patterns that can then be used to understand where we are currently, few come close to Russel Napier. What makes Napier even more interesting is his willingness to make big bold calls, which when combined with his witty writing makes for an entertaining yet insightful read. In this interview with The Market, Napier develops on this Financial Repression thesis, citing why central banks have become irrelevant in today’s context, doing the bidding of indebted sovereigns to inflate away their debt by keeping rates low even in the face of rising inflation. This has ramifications for investors – whilst investors worry about the rising cost of capital that follows high inflation , if Napier is right, that may not be the case this time around. That has implications on asset valuations and also portfolio construction – what sort of businesses can fend off inflationary pressures and yet deliver strong cashflow growth.
On why the supply side constraints driving inflation may not all be transient:
“..in 1994 China devalued its currency… and this triggered a wave of cheap exports from China. For years, we had a massive deflationary wind coming out of China. That isn’t going to happen again for two reasons: One, labour prices in China are up significantly. And two, we are entering a new cold war, which means we won’t be buying as much from China.”
But his bigger reason for inflation is high growth in broad money and even bigger call is on interest rates:
“Over the next ten years, I’d forecast something between 4 and 5,5% in terms of the rate of inflation in the developed world. But mind you: The most important part of my forecast is not the inflation rate per se. It’s that interest rates will not be allowed to reflect that rate of inflation. That is what changes the entire structure of finance. This is the key question: Will interest rates, short and long, be allowed to reflect 4% inflation? My answer is No. This is because we will be entering a period of financial repression, where governments keep interest rates below the rate of inflation, just like after World War II.
…The reason that I come up with this number is the revolution that happened last year: Governments got involved in the commercial banking system, by guaranteeing private sector loans. When I look at the latest data, I see bank balance sheets growing at about 10%, which translates into broad money growth of around 10% per annum. People have to understand that it’s not central banks that create most of the money, but commercial banks. So now governments, through their loan guarantees to commercial banks, can create as much money as they like. Out of thin air.
…This is exactly what happened after World War II. Central banks were impotent during that time. The supply of money was dictated by governments controlling the commercial banking system. I strongly believe that we’re going back to that system. The government can never tell you that, because the whole point of financial repression is to steal money from savers slowly. But this is a fantastic thing for politicians: It isn’t fiscal spending, it isn’t higher taxation, it’s a contingent liability on the government’s balance sheet but not an actual liability. It creates politically directed growth, and it creates inflation. For politicians, it’s the magic money tree.
He reckons even the bond markets are decoupled from inflation:
“Bond yields are depressed by central bank action, and I would argue that they are also depressed by government action. Many insurance companies must hold government bonds due to asset liability models that their regulators have imposed upon them. We are going to discover that, as time progresses, bond yields are entirely decoupled from inflation. That’s the most important thing here. You won’t find one economic textbook which says that bond yields can be decoupled from inflation. And yet there is a long period of history, from 1939 to 1979, where they were largely decoupled. All the textbooks work on the assumption of a free market economy where the free will of investors results in bond markets pricing in inflation expectations.
…Bond yields are telling us today that this is history. They are not set in a free market anymore. And therefore most of the skills investors have learned since 1979 are obsolete. Bond yields will not be a free market price anymore for at least 15 years. We are in a new structure of how things work. I am not making a business cycle call here, this is a structural call. We are entering a time of financial repression.”
He goes onto elaborate on this central premise including his bullish call on equities as well as a peek into his new book on the Asian financial crisis.