Noted financial historian and strategist, Russell Napier, recently joined FS Insider for a conversation about the new inflationary landscape Russell sees the world heading toward. He outlined his change in thinking and explained what this new age of inflation means for investors and especially savers and retirees. See below for excerpts from his interview.
For audio, see Russell Napier on Investing in the Age of Inflation.
Recently, you had a pretty big change in thinking, and you’re now saying we’re seeing the birth of the age of inflation. Tell us about this.
The change in opinion is because of the change in facts, not changing facts. The way money is created has changed. I call it the silent revolution. It shouldn't be a silent revolution. It should be obvious, but I think the markets have missed it. And the reason they missed it is that central bankers have been doing extreme things, I would call those moves monetary pyrotechnics. That has distracted attention from what is really going on here.
So, here's the monetary evolution. Money, really for a few hundred years now, it's not fundamentally created by central banks. It's created by commercial banks. And central bankers tried to steer them with interest rates, with provision of reserves, with changing capital adequacy rules to create money, and they failed to do so over the last 12 years.
The governments have stepped in, and through credit guarantee schemes offered to banks, governments have taken control of the asset side of commercial bank balance sheets. And as is it has been since the invention of fractional reserve banking, when a commercial bank extends assets it creates liabilities—we call it money.
Unbeknownst to most people, the money has moved from central bankers to governments. That's what I call a silent revolution that won't stay silent for long. Given the proclivity of politicians to print too much money and create too much money, we should now be betting on inflation, even if the near-term outlook is for lower inflation or even deflation. The change in that mechanism is powerful enough that the markets will soon begin to price in higher inflation.
Is there anything you’d point out to demonstrate that a regime change has taken place in the way we create money?
Yeah, absolutely there is. The obvious thing to point to is the expansion in commercial bank balance sheets themselves, and we have very good and timely data on that. Heading into what has been our worst recession since WWII, we now have aggressive growth in bond credit. We didn't see that during the economic expansion, which lasted from June 2009 to February 2020. We saw moderate expansion in commercial bank balance sheets, so why would we suddenly see this rapid growth into recession?
Partly, it's due to corporations putting down credit lines. But right behind that we have these government guarantee schemes. And really a good example is the British one. There are three schemes but the really successful one is called the Bounce Back Loan and that is for sums only up to 50,000 Sterling. So, it's fairly small companies, but that is flying out the door at an unparalleled pace because it is 100% guaranteed by the government.
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I mentioned the Bounce Back Loan in particular because it does very clearly show the dynamics. The bankers making those loans told the Financial Times about three weeks ago, that they expect 50% to go bad. These are the classic loans these banks would never have made during the period of quantitative easing because they felt they would have significant losses on principle.
But now they are making them. We're making, I think it's over 32 billion pounds, worth of those loans in a very short period of time expecting 50% of them to go bad. I think that's a clear illustration of how potent and powerful this change in government policy is. But we have those policies running in Japan, Germany, Italy, France, Spain, the United Kingdom, America, so they're not confined to the United Kingdom.
So, the data is quite clear. Bank balance sheets are expanding and broad money growth, by the way, which is almost but not quite a reciprocal of that, has also accelerated to levels, that in America we haven't seen before. It’s close to 30-year highs now across the developed world. There is tangible evidence in the data that is happening. The problem is that most people seem to somehow think this is a reflection of central bank action. I'm saying absolutely not, this is a reflection of government action, and therefore that is a regime change.
Can you explain why financial repression is a redistribution of wealth?
Redistribution of wealth through inflation is nothing new. It's as old as the hills. And of course, the beauty of it is it doesn't need any democratic endorsement. You don't have to go to the electorate to ask for permission, you can just do it when you control the supply of money. The crucial thing here is to suspend market forces while you do it.
In a world where market forces were not suspended, savers would obviously demand a higher rate of interest to compensate them, not just for existing inflation, but for future inflation. And the repression really wouldn't work very well if we were all demanding particularly high rates of interest in compensation.
The crucial part of the actual repression is not creating the inflation but ensuring that interest rates do not rise once that inflation has been created. In such a situation a saver may be forced to accept, let's say 2% interest on 10-year government bonds while inflation is 4%. There is no nominal loss to the saver in that particular situation if the yield is capped at two. But clearly the purchasing part of the saver is going down.
So, this is what I call stealing money from old people slowly— that's what financial repression is. How does the debtor benefit from this? Well, in a world where inflation was let's say 6%, the average citizen was able to get a wage growth of 6%. Remember, it tends to be younger people who are in employment and older people who are living off their investments in their fixed income securities. So, if they were getting a rise in line with inflation of 6%, and interest rates for mortgage rates were 2% or 3%, then this is a powerful movement of wealth from one section of society to another section of society, from savers to debtors. From old people to young people and inflation has been recognized as having that effect for a very long period of time.
I think the thing that most savers don't focus on is just how extreme the measures might have to be to keep interest rates down through that period. And they effectively begin to erode a market system.
Click here to listen to the full interview and learn how Russell sees this new inflationary landscape playing into MMT and what its implications are on asset prices. If you're not already a subscriber to our FS Insider podcast where we interview book authors, strategists and industry experts from across the globe on all things economics, finance and markets...
