Russell Napier, author of Anatomy of the Bear and co-Founder of the Electronic Research Interchange (or ERIC), explains why he sees further deflation and deleveraging moving forward, and why he thinks this will ultimately lead to the spread of negative interest rates into the US.
Here’s some of what he had to say in Wednesday’s podcast:
“I believe we are in for a deflationary deleveraging, which actually began some time ago with emerging markets but just in the last few months has begun to feed into the developed world…
It's very difficult to imagine anyone running a bank today looking at what's happened to their equity price and the price of their bonds that would be extending their balance sheet. The whole capital structure has been priced to say it's time to contract and if they do that, that does not create money, that destroys money—one of the joys of our fractional reserve banking system…
It's very easy to look at the markets today and say they are disassociated from the real world; they have no contact with the real world; they're ignoring the real world; well, the cost of credit in Europe is going up pretty dramatically because the banks are being forced to contract their balance sheet and in the United States the same thing is happening but through the bond market...particularly through the high yield bond market...
Central banks never imagined it would get this far because they imagined at some stage they would get some help from the politicians in terms of reflating the economy but we have political paralysis particularly in Europe and the United States. So the central bankers are trying to achieve something with the price of money and it's not working so they are being forced further and further than they wanted to go."
Scroll down to read more of his comments, or click to hear a preview of his interview below.
"Ultimately the solution to this is the politicians will be galvanized into extreme action to try and create reflation. But it's the nature of the political process—that is, a reactive and not proactive process so we probably have to have some failure first...
The Bundesbank is not known as an alarmist organization but they wrote a paper—it must’ve been 18 months ago—on the German insurance industry saying that with interest rates at the level they were then, over 20% of the German insurance industry would be bankrupt by I think it was by 2019. Now, interest rates have gone down dramatically since then so the situation can only be getting worse; in other words, the rollover investment yield that insurance companies get has basically evaporated—it's gone negative.
So [with negative rates] those are business models that don't make any sense. Elsewhere, the more the rate on deposits come to negative, the more risk there is that people start asking for bank notes...that's a bank run if we ever got to that stage, but even with negative rates where they are it's destroying the returns for banks.
When you've built hundreds of years a system that runs on positive nominal rates and you suddenly deliver negative nominal rates, then you are creating lots of problems for lots of existing business models and it's going to cause havok and I think it is causing havok...
Can [negative rates] come to the United States? And the answer is probably yes. Once again, it really depends on how quickly the politicians get in gear. Central banks I think are crying out for help from the politicians in terms of getting some form of reflation going...so I would forecast that America probably will get to negative nominal rates.
I do think that what's going on in the world with European banks and in the high yield market in the United States and the potential defaults in the emerging markets, I do think that's negative for US economic activity; I do think inflation will continue to come down in the US; I do think the US will report deflation, so probably the United States has to go the same place as most other places have gone to.
The most important thing that your listeners need to remember is that just because central banking has played out doesn't mean to say that the [political] authorities have played out. So they'll be back with some sort of political machinations to try and produce this higher level of nominal GDP growth...and eventually they'll succeed but, crucially, it needs a crisis to galvanize the political process…"
Listen to this full 30-minute plus interview with Russell Napier by logging in and clicking here. Not a subscriber? Click here.
