«In the future, nobody with ambition would want to work for a central bank.»
In many parts of the world, financial repression has staged a comeback right after the global financial crisis of 2008. It used to be a popular policy instrument after the Second World War to overcome enormous debt loads. And again, governments try to deal with debt by keeping yields low. Yet, according to Russell Napier, independent market strategist and bestselling author, this is only just the beginning and the world of investors will be turned upside down.
Mr. Napier, what has been the biggest surprise to you this year? It cannot be inflation because you have predicted this comeback since the start of the year.
The biggest surprise to me is definitely the gold price. Because inflation is up big time, rates not so much, thus real rates are negative in many places and yet the gold price has hardly budged. Had you told me a year ago, where inflation and rates would be, I would have forecasted the gold price to be a lot higher today.
Do you have any explanation why gold did not move the way one would have expected it to do?
When the equity markets had a meltdown in March 2020, many investors fled into gold. They were unnatural gold buyers, who would usually not touch precious metals. People were simply afraid that the financial system might collapse because of Covid. Once stocks recovered, those investors sold gold again and moved back into equities. That overhang continues to dampen price dynamics in gold. But that will not last forever.
So, the next crisis is just around the corner?
Yes, the next crisis will be different and is such that people worry that the purchasing power of their money is undermined structurally, so they turn towards real assets and gold in particular. That is a different type of crisis than the one we witnessed in 2020. Last year they worried about banks collapsing and they were rather worried about deflation.
Investors turn to gold in deflation as well as in inflationary times?
In a highly leveraged system, deflation will cause bankruptcies and investors worry about solvency. So, they choose gold as a safe haven which has no counterparty risk. In these instances of deflation, it’s all about avoiding counterparty risk, which has not happened too often in the past but it did happen, briefly, last March.
And gold should do well in a high inflation world as well?
Gold performs well in a world where real rates are very low or even negative, as they are now in many parts of the world. So, over the next 10 to 15 years, gold investments should do well.
You expect real rates to remain negative for the next 15 years?
Yes, absolutely, that is a fundamental call. I do not expect inflation to come down. I’d buy gold now and hold it for at least another decade. We will enter the next stage of financial repression. That repression is an essential policy choice aimed at reducing the world’s record high debt-to-GDP ratios.
What exactly is financial repression all about?
To put it bluntly, you steal money from old people slowly.
How is that?
You tolerate or even encourage inflation to rise while keeping nominal yields low. Savers – very often elderly people – will suffer and debtors will love it. And governments are big debtors. They have every incentive to inflict this combination of high inflation and low interest rates to alleviate the debt burden. Financial repression is the only politically feasible way to shrink the enormous debt mountains. And in financial repression, governments, often via the regulation of investment institutions, tell people where to put their money. When that happens, gold tends to become more valuable because you can hide it. Gold is easier to hide than a bond or an equity portfolio.
Which other assets will profit in financial repression?
Real assets would be high in demand. Just look at the seventies as a template. Old master paintings were sought after, classic cars and of course real estate assets. Inflation is a tax, and people will seek ways to escape this tax – they always have done.
Your point is that governments will more or less directly steer money flows?
We will witness the politicisation of credit. Governments will determine who gets credit and who not. And commercial banks will be merely executing the governments desired allocations of credit.
And upon which criteria will the selection process of the government be based?
The governments will push finance towards those ventures most likely to meet their political goals such as greening the economy, creating employment or funding home buyers. Commercial real estate will have a hard time getting credit because it is not as productive and useful compared to green or home mortgages or compared to building factories to employ people. Private equity will not be seen as being productive either. Private equity basically borrows money and gears up an existing income stream. That does not translate into employing more people.
This vision of yours sounds like the end of the free market or at least a massively distorted market.
It is not a vision. The Bank of England has set up a committee called «The Productive Finance Working group» about a year ago. It includes the Central Bank, the Treasury, the regulator and 17 investment institutions. It is happening already. They set out to define what productive is and what not. And you can steer capital allocation in very subtle ways using the powers of the regulator. Many countries will move along the spectrum from the market economy end towards the command economy end of the spectrum. For investors the world will turn upside down from what they have known for the past forty years.
Which subtle ways are you thinking of to influence capital allocation?
The goal is to force investors into buying government bonds in order to keep yields from rising. To that end you depress returns of other assets and make them unattractive. You might levy a stamp duty on equities or introduce rent controls to keep real estate returns in check. Or you may introduce a new green standard for lending and for anything that the government defines as green, commercial banks will not have to hold any capital against. This is how the politicisation of credit works. And when a government – not the private sector – defines what is productive, then we are in big trouble, as history very clearly shows.
This does not sound as though the future of equities is very bright?
In the long run, it is a bad scenario for equities. In the short run, however, I am still optimistic for stocks because that is the place to go when inflation rises. In the long run, it will hurt equities when government measures start to undermine corporate earnings. However, the negatives from the inefficient allocation of capital can take years to come home to roost.
Which economies are most likely to move towards such a fierce version of financial repression?
Just look at total non-financial debt-to-GDP ratios and the answer is obvious. Who has such a high debt burden that they have to inflate it away? These governments will be forced to pursue financial repression which massively distorts the cost of capital and thus capital allocation. In assessing debt burdens far too often people just look at government debt-to-GDP only, but that does not reflect the total debt burden an economy has to shoulder. It is government as well as private debt, the sum of debt accumulated by households and corporates, which constrains policy options. Total debt-to-GDP in the US stands at 293%, same as in the Euro Area – new record highs. In Europe, however, France stands out negatively with a ratio of 371%. France is a big economy and thus the weakest link in the monetary union given the problems in creating a monetary policy suitable for France and simultaneously for Germany – a country with a total debt-to-GDP ratio of just 209%.
Would France be able to weather rate increases?
No, the ECB will not raise rates because if interest rates were to rise above ECB inflation it would bankrupt France. Forget about Greece or Italy, France is the culprit. French corporates have a huge pile of debt. But Christine Lagarde is a politician much more than a central banker. This is a job for a politician. This is why the Germans keep resigning from their jobs at the ECB as they know the organisation has to pursue political goals and not price stability goals. Christine Lagarde knows that central bankers are more or less obsolete in a world of financial repression and as a lawyer she is compliant in the new task at hand – to inflate away debts in the pursuit of political goals.
There will be no more need for central banks?
Central banking will be a backwater. If the government determines what the yield curve looks like and where and how much money will be flowing, through controlling commercial bank balance sheet growth, central bankers will have nothing to do. Whoever controls the yield curve and whoever controls the commercial banks, ultimately controls monetary policy. The young and talented will strive to get a job in a government entity and deal with industrial policy. This is where the kingmakers are, as they determine what is funded and what is not funded. Nobody with ambition would want to work for a central bank.
Is the monetary union threatened by financial repression?
It will cause a nationalisation of capital flows which is against the fundamental idea of the single currency. As time passes, national regulators will, more and more, force local financial institutions to fund local governments and local ventures that the government wants financed. That policy contradicts the right to the free movement of capital within the Eurozone, but it is already happening and will intensify. On a one-country-basis, such as the UK or the US, you move money from savers to debtors within the country and this causes political tensions. In the monetary union you will have to move money from Germany to France. German savers will have to bail out the debtors of France and elsewhere. This need to move wealth cross border, through the actions of an unelected central bank, will be fraught with political danger.
And why are you so convinced that inflation will remain elevated?
Inflation is driven by the growth and supply of money, which is at very high levels. That distinguishes the current environment from the situation after the financial crisis when the money created by central banks did not make it into the private sector. In the US, broad money was growing at a speed of 27% in February this year. It has come down to 13,5%, which is still very high by historical standards. There is no way that inflation is transitory with such a speed of money growth.
The strong growth in bank credit will not be ultimately stopped by the government?
Governments like high credit growth, because it funds all the things that they need to get funded. They have a green revolution to fund as well. You cannot vote green and want low inflation at the same time. This is the new normal and inflation is not transitory. Stagflation is a product of financial repression.
Can you specify that link?
Repression leads to a massive misallocation of capital. Capital does not flow to the right places to create jobs. This causes high inflation and high unemployment to occur at the same time. When the word stagflation was invented in 1965, it had taken 20 years since financial repression was invented after World War II to fully unfold its negative consequences.
To close this interesting talk, do you have something optimistic to say?
As I said, some equities can still provide inflation-beating returns in the short term. There will be a capital expenditure boom in the developed world which creates opportunities in specific equities. The developed world needs to build capacity to replace Chinese capacity which will be increasingly off limits for imports due to our growing cold war. We will also need to invest to green the economy, reduce the length of supply chains and replace ever more costly labour. Some companies will really benefit in providing the machinery and equipment necessary for this great capex boom. Thus, stock pickers will experience a boom time, because investors will have to be more selective. I prefer value over growth stocks. And with the exception of China, I like emerging markets because their debt ratios are not as stretched and they got room to maneuver. Do not buy bonds unless they are inflation-protected. Finally, gold is the standout asset class for financial repression and thus for this generation of investors.