Episode 5 of The End Game saw Russell Napier join Bill and Grant for a head-spinning conversation during which he lays out the reasons why he has, after two decades, stepped off the deflation train and hopped aboard the Inflation Express.
Russell delivers his message with his customary insight, encyclopedic historical knowledge and wit and lays out a compelling case for 4% inflation in developed markets a lot sooner than many believe either possible or probable.
Russell takes us back to 1695 and the beginning of modern-day banking for a little perspective before bringing us bang up to date with his thoughts on the many government stimulus programs being rolled out which, he believes, change the game for good.
Grant Williams:
Here’s the bit where I remind you that nothing we discuss during The End Game should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do research or speak to a financial advisor before putting a dime of your money into these crazy markets. And now, on with the show.
Grant Williams:
Welcome everybody, to another edition of The End Game. Joining me as always, my good friend Bill Fleckenstein. Bill, hi mate.
Bill Fleckenstein:
Hello mate, I’m happy to be here. I think today’s discussion is going to expand a lot of people’s minds, let’s just put it like that.
Grant Williams:
Yeah, I think so. We’ve sat and got our heads together and really drawn up an all star list of people that we think can help us, if not work out exactly what the end game is, certainly get people thinking about all the different possible outcomes. And after James, and Mike Green, and Jim Grant, we have another fantastic guest joining us today in Russell Napier. Russell’s a huge hero of mine, I’ve followed his work for way too long. Decades, I can genuinely say that. He’s a fantastic thinker, he’s an incredibly gifted communicator, and apart from that he’s just a fantastic bloke. He’s been a deflationist or a dis-inflationist I think, for a couple of decades now. And he’s stuck to his guns over that.
Grant Williams:
And you know Bill, every now and again you get an article that comes out or an interview that comes out, and you suddenly find like 25 people forwarding it to you saying, “Have you read this? Have you read this? You read this?” It’s just one of those. And a couple of weeks ago, Russell was interviewed on a website, themarket.ch. I would recommend you go to that website and read that interview. And I mean, I was flooded with people saying, “Have you read this? Have you read this? You read this?” And I had, and everyone I replied to and said, “Yeah, I’ve read it, but it’s an extraordinary conversation.”
Bill Fleckenstein:
It’s not very often that you get people to change a view like that as he has done, and especially when they’re well thought out and were well thought out before, so it’s going to be interesting to see what he has to say.
Grant Williams:
Well why don’t you and I stop waffling and welcome him on, and welcome Russell to the show. Russell, come in. Are you there?
Bill Fleckenstein:
So Russell, can I ask you kind of a leading question? Is that all right?
Russell Napier:
Sure.
Bill Fleckenstein:
So I’ve been over the recent Q&A you did with The Market, whatever that publication is, and I was kind of curious. What was sort of the gestation period or the process where you kind of shifted gears from what you’d been thinking before, to where you’ve come to this viewpoint that’s quite clear in the Q&A? Was it kind of a long process, or could you kind of see it coming for a while and then finally when something happened you said, “Aha, that’s it, I think it’s going to go this way.” I mean, since it kind of seems like a radical change from where you were before, could you share how that happened?
Russell Napier:
Well it’s been my view for many years that come the next recession, which I thought would be a deflationary recession, which I still think this is, there would be… something would happen to change that. I think we all thought it would be modern monetary theory, and we’ve got a little bit of modern monetary theory. But the answer to your question is, it came really quickly to me, because I realized one afternoon that these bank credit guarantees are it. And obviously they didn’t exist in March… or they didn’t exist in February, but March, April, they existed. So suddenly it’s there, it’s sitting in front of you.
Russell Napier:
And of course there’s confirmatory evidence, because bank credit growth is very high, and broad money growth is very high. But for me actually, it was the mechanism, that bank credit guarantee was the thing. Now, that’s not to say you wouldn’t also get modern monetary theory, which I’m sure would achieve the same thing, but I think our governments will find a different way of doing it, a more surreptitious way of doing it, and actually a more effective way of doing it in terms of where the money goes. So that’s the answer, but I didn’t think it would come in this variety, but it came really quickly and kind of universally.
Russell Napier:
I mean, if you look around the world, they all seem to have discovered it simultaneously. Rather than MMT, they seem to have come up with this quite quickly.
Grant Williams:
It seems as though this is a much easier thing to get through as well, Russell. The MMT thing, because it has this… because there’s a lot of kind of debate around this, there’s a lot of conjecture around it, and it’s had enough publicity that at the beginning was a good thing for it, but now enough people are kind of attuned to what it might mean that it’s kind of tough to get it through. Whereas this has happened without really anybody except you taking any notice of it.
Russell Napier:
Yeah, I agree with that. And I am not a fan of MMT, I just think it’s currency divestment straightforward. This is something different. It can have that effect obviously, but what is it doing in the short run? It’s sending money out into the economy to people and small businesses in distress. The history of action from DC was that it would be like big businesses, and small businesses could go to the wall, so it’s very hard to argue against it when the initial impact is to keep in business lots of small businesses and households. And I actually don’t see anybody arguing against it. If it had been outright MMT, there would’ve been stuff on the front page of the Financial Times against it. So this is more… what’s the right word? It’s just less virulent as a monetary policy. It has its positives associated with it. Nobody has to really vote for it either.
Russell Napier:
And the most important thing is you don’t even have to pretend it’s government debt. So the MMT-ers will say that we’re lending this money to the government, they wouldn’t say lending, but I think the population would look at it and sort of treat it as a loan. This is a contingent liability on the government’s balance sheet, so it’s not on the government balance sheet. And my view is that when it comes home to roost, they might have to put in a couple of billions in the banks to compensate them for loss of principle. They’ll soon be rolling over the loans so that everybody can pay back their principle. This is the way we’ve been running banks for a generation anyway, so it kind of hangs there as a contingent liability. Your government debt doesn’t go up. People who vote for you get money.
Russell Napier:
And I keep drawing attention to the longer term consequences of that, which are inflation, but frankly as a politician, when you weigh all those things up, they’re massively outweighed by the positives, and the negatives are so far out there. So for all my friends who are MMT-ers, which I think is kind of nutty policy, to me it’s rather ironic. They kind of got within three feet of the finish line, and suddenly this other horsecame up and beat them by a nose.
Bill Fleckenstein:
I have a friend of mine who runs a big bond portfolio, and he’s made the similar point that the big difference between now versus say, the prior decade, is it was the PPP here, where government guarantees are in place. I saw in the Q&A that you did that this happened in Spain. I think you just mentioned the other places. Can you cite a couple of examples? Because it was completely news to me that that had happened, I had missed it.
Russell Napier:
Yeah, sure. So the reason I thought the Spanish one was interesting is it started as a 100 day guarantee, and then one afternoon it was 150, just like that. Just wave a magic wand and there it was. Because one of the bits of pushback I get on this view, Bill, is it’s an emergency program and it will stop. And if that’s right, I’m probably wrong. You get this one pulse of credit and money into the system then it stops, then I’m probably wrong. My argument is that this is the magic money train and it’ll keep going. So the Spanish one was quite, because it shows how it grows.
Russell Napier:
The Germans have got one of the fastest growing banking systems in Europe, so the Germans were quick and efficient in getting this underway. So it’s not as if it’s, let’s just say the European states with lesser, history of lesser credit quality and more inflationary doing this. The Germans are very good at doing it. I think the best one is the British one, actually. It’s called the Bounce Back Loan.
Bill Fleckenstein:
Say again please, it’s called what?
Russell Napier:
The British one is called the Bounce Back Loan, so there are three different loans in Britain, but the one that’s really taken off is the Bounce Back Loan, and I think that’s really instructive. Because the other two were for big companies, but the one that’s really flying out the door is the one for small companies, Bounce Back. The maximum loan you can get on that is 50,000 sterling, so that gives you some idea of the size of company that might be taking it. 23 billion went out the door in the first six weeks.
Russell Napier:
Bankers, senior bankers went to the Financial Times and explained that they thought 50%, five zero percent of these loans would go bad. It’s 3.6% interest rates for six years. I know lots of people who’ve taken them even though they didn’t need the money, the business didn’t need the money. An acquaintance said you’d be nuts not to take the money, so everyone’s taking them out. Those are the loans the bankers never made on your QE. If the banker says to you, 50% of this will go bad, these are the loans you wouldn’t make under QE. Because he had to take the entire risk. Okay, so he was given very cheap interest rates, but he took the entire risk. Well now you’re not taking any of the credit risk. So it’s flying out the door. I’m sure there’ll be more of these to come as well.
Russell Napier:
So that’s just some examples. I mean, if we look at bank credit growth in Japan, it’s just gone shooting up as well, from almost incredibly low levels. And it’s really reciprocal of money supply growth, but where isn’t it going up?
Grant Williams:
Yeah Russell, everywhere you look the pieces are in place for a return of inflation. Everywhere you look. And the things you just mentioned there, just more grist to the mill in my view. And yet we still have this massive reluctance on the part of everybody, and not just inexperienced people, but experienced people to actually believe that inflation can come back. Why do you think potentially this time, people are missing the trick? Because you held firm for what, two decades? With your view. And you rode this trend all the way down. And Bill and I have been talking about this, and it’s interesting to now start to see people who have been so solid with a viewpoint that’s been right starting to say, “Okay, we’ve reached the end of that trade now.” So why do you think people struggle to believe that inflation is even possible anymore, and what signs should we be looking for that, God forbid, you’re absolutely right?
Russell Napier:
So I think it’s time horizons, apart from anything else. So even I would concede that inflation could go lower before it goes higher, so there’s some people I think just trying to leave the party at one minute to midnight. And there are many people who get paid for trying to leave the party at one minute to midnight, so who can blame them? That’s what their incentive package is backed on. So I meet people every day who say, “You’re right, but it’s two years away. You’re right, but it’s three years away.” So I think even people who believe in deflation think that something will change, it’s just a matter of when it changes. The fundamental pushback I get on my argument is, well this is a monetarist argument, and monetarism is dead. That’s kind of what you get. We know that all these money stuff doesn’t work anymore. And I’m prepared to have a debate on that, and at certain levels of money supply growth I think it tells you actually nothing, and is completely useless and worthless.
Russell Napier:
And then one morning you wake up, and everyone’s got double digit money supply growth, and I think that’s the time to at least pay attention. Ifbroad money growth in the world, which obviously they put out a broad money M3 number, and as of about six months ago, that was the lowest it had ever been in recorded history apart from 2009, and yet nobody was really looking at it. That rate more than doubled in four months. I think that’s a big enough move that you can at least raise the question. So people just think it’s a money argument, money doesn’t matter, hasn’t mattered for 40 years. I think it would matter a lot if we had some sort of blended measure of inflation which included asset prices. I don’t think anybody’s claiming that money has a direct relationship to consumer price inflation. But if we had some sort of better blended thing, including asset prices, that it probably would. Everyone just thinks this money goes into asset prices. We always know it goes into asset prices, so it’s an argument we can have.
Russell Napier:
I think there’s a big difference between a central bank balance sheet growth and broad money growth. One of those is very good for asset prices, and the other one is going to be more causative for consumer price inflation. But I can’t persuade anybody of the argument, because we just had 10 years of central bank balance sheets going like this, and asset prices were the only beneficiary. So that’s called, I think that’s called Pavlov’s dogs.
Bill Fleckenstein:
Well maybe what we can do is, we might have some listeners who don’t quite understand why the banks making the loans make such a difference, versus what we saw prior to this. I mean, the three of us understand what you’re saying, but for the benefit of people maybe who don’t quite get that, can you give them the quick and dirty on why that will change what’s happened going forward versus the last 10 years?
Russell Napier:
Yeah. So the quick and easy answer to that begins in 1695. So that’s … So I have in my hand a little piece of gold, which is now worth 345 pounds unbelievably, and this is a sovereign. So in 1695, some gentleman not far from here decided to start a bank. So they went out and they raised some capital, and all they did was really buy the stuff. And what they did is, they put it in a pile over here, and they accrued a large pile of this. There was no paper money in circulation anywhere in Edinburgh, the First Bank of England note had probably just come over the border. And what they did was they didn’t take any deposits, and they didn’t offer any interest rates. But what they said to people is, “Look, here’s our gold, and we’re going to lend you money. And what we’re going to lend you money in the form of is a piece of paper. So you come into us, here’s a pound. We will charge you 6% interest, and we give you this piece of paper. And that piece of paper is a receipt for this piece of gold, and that’s it.
Russell Napier:
So they took it out onto the High Street of Edinburgh, and they spent it. And everybody took it, because everybody realized there was a little pile of gold, so everybody knew that that piece of paper got you gold. And within years, they soon realized that no one was bringing the pieces of paper back, and nobody was asking for gold. So suddenly there was only 10 of these behind the counter, and there were 25 pieces of paper floating. And in that moment, the commercial banks were in the business of making money.
Russell Napier:
It is exactly the same today. It hasn’t changed. It’s not gold behind the counter today. What’s behind the counter today is something we call commercial bank reserves, which is a right for those commercial banks to… they have reserves with the fed, and they can turn it into notes and give you notes. But when these commercial banks expand their balance sheets, they create money. Money is created. I mean, it’s the nuttiest thing in modern monetary theory that they pretend that they don’t. And as to why they pretend that they don’t I really haven’t the faintest idea.
Russell Napier:
So what’s happening, when the central bank expanded its balance sheet is flushed the modern equivalent of these things into the banks. And the banks themselves didn’t really lend, so we didn’t create a lot of extra money. And that’s what’s transformed in the current situation. And because of that guarantee the governments have given to the banks, they feel pretty relaxed about lending. They know they can’t lose very much money, so they’re in the business of creating money. That’s my short, the history of paper money, 1696 to current.
Bill Fleckenstein:
Well done.
Grant Williams:
You know what Russell, the amazing thing is, it’s so telling that you can actually tell that near 400 year story that quickly, right? Because it hasn’t changed. It’s the same things they’re doing today as they were all those years ago.
Russell Napier:
This isn’t gold anymore, but otherwise fundamentally it hasn’t changed. And I think it’s because this isn’t gold anymore that people don’t understand that it’s the same mechanism, because they don’t see anything tangible. And I say the notes are not backed by anything and it seems to confuse everybody, but the mechanism is the same, except we replace this with the reserves a commercial bank holds with its central bank. And everybody watching this will know that those reserves are in wild abundance at the minute because of quantum easing, and then because of what’s happened with central bank balance sheets since then. So there’s no shortage of this stuff for a bank-
Bill Fleckenstein:
And there’s going to be no shortage of people dying to get loans given what the virus has done to the economy everywhere, right?
Russell Napier:
I think that you’ve probably seen that the sale of super cars in the United Kingdom is booming, and most people are using the Bounce Back Loan as the deposit on the super car. I was looking at the sale of boats and yachts in the United States of America, they’re up 150-200% year on year. And once again, Small Business Administration loans have been pretty useful as a deposit on your yacht of choice. So it’s not just the people… and I’m being a bit cynical here, but people and businesses need this money to survive, which is perfectly legitimate, but my goodness there’s a lot of excess. Perfectly reasonable businesses are taking this money out to fund the owner’s peccadilloes, let’s put it that way. So there’s plenty of money sloshing around in the system, and there’ll be plenty of fraud in this as well. I mean, I keep joking, and maybe I shouldn’t joke because I’ll pay a high price. There’ll be lots of very fine wine drunk on the shores of New Jersey with some of these loans. I’ll let you [inaudible 00:17:18], you’ll be drinking it. It’ll be fine red, and it won’t be from France.
Bill Fleckenstein:
You just made a point a while back of something that I see very little discussion of, and it’s something I’ve thought about for a long time. And that is the distinction between asset inflation and CPI inflation, and it seems as though people feel that asset inflation is always 100% good, nothing bad can happen. The potential for unintended consequences of misallocated capital seems never to be discussed, and it seems to me that perversely, it’s only in periods where it doesn’t seem like there’s any CPI inflation that they can let asset inflation run wild, and that’s kind of been the story the last 20 or 25 years. Why is it do you think that so many people seem to act like asset inflation doesn’t matter, and only a little CPI inflation matters? Why do you think that bias is the way it is?
Russell Napier:
I think it’s because of the issue with debt out there. And what Pavlov’s dogs have learned is that as asset prices go up, people gear them up. And therefore when the time comes for them to go down, the authorities can’t afford for them to go down, so they’ve kind of come to the conclusion that it has to be a one way bet because the consequences of falling assets in a highly geared system are so negative that it can never, never, never is the biggest word in finance, can never happen. So they’ve come to believe that it is a one way bet socially and politically. It’s simply a one way bet, so there be never any negatives. The obvious negative for asset prices is they also come down and bankrupt the entire system. We’ve now seen it twice, but we’re led to believe that it’s no longer a negative, because you’ll always have somebody beneath you to stop it from happening.
Russell Napier:
Remember, crucially the central banks were never given an asset price target, they were given a CPI target. I mean, that’s probably been the problem here, they had the wrong target. Not that they should’ve been explicitly targeting asset prices, but when you gave them the inflation target, it took interest rates to a level that were incredibly beneficial for asset prices and incredibly beneficial for those who wanted to gear the hell out of asset prices, and that’s the 25 years you’ve just spoken about. I reveal it here for the first time, but I’m writing a new book that’s exactly on that 25 year period, which is the 25 years I’ve been writing. And it’s called More Money than Sense, which is the best title I can think of.
Bill Fleckenstein:
That’s brilliant.
Russell Napier:
Yeah, I’ve revealed that, I hope nobody else steals it between now and Christmas.
Grant Williams:
Trademark Russell Napier. You know, it’s interesting Russell, I was looking at a chart when I was writing something a couple of weeks ago. And when you go back and look at GDP per capita, you look at median incomes, the only time in the last 35, 40 years, where the top 10% standard of living has fallen more than the bottom 90% is after the savings and loan crisis, when obviously assets were impaired and we saw a lot of asset prices deflate and be allowed to deflate in the wake of that. And it almost feels as though that’s something that isn’t really talked about much these days, that particular crisis. It kind of came and went, and everyone remembers Charles Keating’s name, but they don’t really remember much about the savings and loan. But it seems that that, as I researched it more, was much more of a turning point in terms of understanding exactly what you just put out there, that this game of inflating asset prices is crucial.
Russell Napier:
Yeah, I used to see Paul Volcker very occasionally, maybe once a year, and the first time I met him I just asked him, “Where did it all go wrong?” I feel like that was the question. And he was adamant that it was LTCM. That was the bailout where it all went wrong. So that 80s bailout, I mean, there were people who got away with things in that as well. But as you said, on the whole assets were impaired. But as soon as LTCM came in, everybody who had assets or everybody who could gear to buy assets from 1998 to 2020 did so, on the belief that they would never be allowed to lose money, and on the whole that was a correct belief. And there are good reasons why we have inequality in society. Not all of us are esteemed jobs. So there’s always going to be esteemed jobs out there, and thank God for them who will transform the world, but there are also bad reasons. And I would say one of the really bad reasons is the overuse of debt to gear up existing assets and existing cash streams.
Russell Napier:
I don’t know whether you agree with that, but I don’t think it’s been a particularly productive use of capital. It’s been a massively tax beneficial use of capital. It should never have had that scale of tax benefit compared to equity. Now, I’m not against buying assets by any means. I’m not against enhancing the returns on them. But to make it so attractive in terms of the interest rate, in terms of the tax deductibility, in terms of bailing out people who did it, really produced massive inequality of wealth through financial engineering. So I would draw a distinction between financial engineering and capitalism and say they’re two different things. And post-Milken, we developed a different form of capitalism, which has not been beneficial for capitalists I would argue as well. It may ultimately be very, very dangerous for capitalism, because most people lump them together, say they’re the same thing, and want to destroy both of them.
Bill Fleckenstein:
Yes, as we’ve evolved in the last 20 years since LTCM in ‘98, it’s become much more crony capitalism, and the bifurcation of wealth has increased. And so I think that observation is exactly correct from my perspective, that it’s done more harm for capitalism as a brand so to speak, not to mention the fact that it’s warped so many things. In the book that I wrote about the fed, I’m really happy to know that that was the moment Volcker pointed out, because that’s where I thought that’s when the fed lost its mind, when they didn’t let LTCM go. They made all those rationalizations and things like that, but I think everybody got the memo after that exactly as you say, and have behaved accordingly.
Russell Napier:
You might remember, the front cover of Time Magazine had the Committee to Save the World. Three of them, there was Greenspan, Summers, and Rubin.
Grant Williams:
Rubin, yeah.
Russell Napier:
And let’s not forget there were three of them. It wasn’t just Greenspan, there were two others as well. And all three of them would’ve said they were defending capitalism, but I think they may ultimately have sown the seeds for its destruction.
Grant Williams:
Yeah, that’ll be interesting to watch. You know Russell, some of the things that you’ve talked about in terms of what may happen from here, because obviously this… if you’re right and the return of inflation is a real possibility, which I have to say I agree with, it creates a whole different set of problems. Some of the solutions to those problems from the point of view of lawmakers and central bankers are pretty dramatic. Perhaps you could just talk a little bit about what they may, I would imagine, be forced to do in order for this transition to work.
Russell Napier:
Yeah, so there are two things. Number one you have to create the inflation, but then number two you have to stop interest rates from rising, and that’s not just short term interest rates. That’s the whole yield curve. That’s what I’d like to focus on, because I think people watching this will have formulated their own opinions on inflation or not, and my mechanism for why that’s being created. We’ve done that before. So I’ve read, just recently read The Deficit Myth, which is just a remarkable piece of work. But in that, Stephanie Kelton points out that the Federal Reserve have indeed controlled the yield curve before, and that was from 1942 until 1951. And she says look, it can be done, obviously it’s a wonderful thing because it was done before. What she failed to mention when she did that is that during that period, America had rationing, price controls, credit controls and capital controls, and forced purchases of government debt.
Russell Napier:
Now against that background, of course you can have relatively low inflation. But believe me, if you lived in America from ‘41 to ‘45 and you were buying stuff in the black market, there was rampant inflation. So that excess money created in that process and whole environment created massive inflation, except for price controls and rationing. And I think it’s the biggest problem I have with people when I try to explain this, is none of them understand the huge effort it takes to hold that yield curve down. It’s like you wave a magic wand and it happens, because it cannot be done by the Federal Reserve.
Russell Napier:
It cannot be done by the Federal Reserve. The yield interest rates would all start to rise because we’re all worried about inflation. The last thing that can then happen is the central bank commits to an infinite rise in its balance sheet, to buy the treasuries and cut the yield curve. So instead, what has to happen is they have to force savers to buy that stuff, and that is exactly what happened after World War II. It was the savers who were forced to hold that stuff while inflation was higher. And government bonds, particularly in Europe where it was a much bigger problem than America, were called Certificates of Confiscation.
Russell Napier:
Now there are all sorts of issues there with liberty and freedom if you start forcing people’s savings into these things, so you’re hitting at kind of the very core of what society is. And when you raise that with an MMT-er, they basically say, “Well savers deserve it,” which may have been what they said in the Weimar Republic as well. But there were consequences of wiping out these savers. I mean, it’s easy to… look, if we decided to do that, the richest people in the world I think would probably get richer, and what I mean is the richest thousand people in the world, because they’ve all got good lawyers and accountants, and that’s a form of taxation which they can avoid. What you’re wiping out is your middle class. Your doctors, your lawyers, your healthcare workers, whatever. And societies who wipe out their middle class tend to pay a pretty high price for it. So that’s what, [inaudible 00:26:52] cap the yield curve using savings, it sounds so innocuous, rather technocratic, fairly boring. But actually it changes the nature of what a society is.
Bill Fleckenstein:
Well a question I have is that, I understand if they try to bring yield curve control at a moment in time when the bond market is already saying, “No, no, no, no, you’ve already overdone this,” why that’s pouring gasoline on a lit fire, and the bond market’s going to win that argument after a while. I mean, the central bank can win for a time. But why wouldn’t you see the same adverse reactions if they try to mandate it? I mean, you can force some people to do some things, but you’re still going to get the backfire anyway aren’t you? Because basically what you’re saying is psychology has changed, and they can’t get that genie back in the bottle.
Russell Napier:
Yeah. I thought we were going to get a bit of Lincoln there, you can force some of the people some of the time and all of the people some of the time, but you can’t force all of the people all of the time. And the answer is, you really can’t. And remember, we’re not talking you and me, forcing you and me may be somewhat difficult, but we have regulated institutions. And once you regulate an institution, you can force it to do anything. So I’m not saying that there’ll be a lot that you Bill, have to liquidate all your investments and buy government bonds. But if you’re running a shop that runs mutual funds, or life insurance funds, pension funds, with a wave of a wand congress can mandate that you hold these instruments. So that’s what I see as how it will be done, and that is all done under the guise of macroprudential regulation. Which is wonderful, because it’s a little phrase that almost scans with motherhood and apple pie. I mean, how can you be against something that’s prudential? That’s an act of marketing genius, this macroprudential regulation, because going against it, you sound like you’re some madman running through the streets of Portland if you come out against macroprudential regulation.
Grant Williams:
It’s so interesting, because this change from deflation or dis-inflation, however you want to characterize it, to inflation, is a huge secular shift. And it’s one of those shifts that we as human beings have a big problem trying to understand and deal with. And yet, this seems almost more difficult for people to understand than people out in the streets protesting physical representations of a shift and a change, or maybe reaching the end of some kind of cycle. People can almost get their heads around those, but the pernicious effects of this change from disinflation to inflation are perhaps more dangerous for more people than what we’re seeing happening in the chairs, God bless it, near Bill.
Russell Napier:
Yeah, I would divide that up. I wouldn’t say people, I would say savers specifically.
Grant Williams:
That’s fair.
Russell Napier:
Because you’ve got to remember, for the average guy in the street, for the first few years this could look pretty good. I mean, if we could engineer a world with a 30 year fixed rate mortgage rate, never goes above three, but wages are growing at seven, for the average guy in the street that’s pretty good. Now, I would make a very strong case as to why over the long case, it all turns bad even for the average guy on the street. This is a direct attempt to move money from savers to debtors. So there are many people who’d benefit from this, so it is striking at this schism in society.
Russell Napier:
The problem with inflation, and Friedman said this and it was said long before him, is that it’s a taxation without legislation. But be in no doubt what it’s supposed to do, it’s supposed to move money from one section of society to the other. I actually don’t have a problem with that if you pass it through congress. If you go to congress and you get elected, lower house, upper house, and president, and what you want to do is move money from one section of society to another, well you may not like it if you’ve got the money, but it’s all done legitimately through the political process. This is to be done illegitimately, and that’s my main beef with MMT. They want to do it secretly. So the problem as you say Grant is that savers haven’t… well in modern times, they haven’t had to cope with this new form of taxation, and they’re ill equipped for it.
Russell Napier:
But be in no doubt that it actually benefits many people, and that’s why it’s a preferred policy. That’s why softer monetary regimes are a product of democracy. We shouldn’t forget that. I mean, the gold standard ends roughly when we get democracy. Until women get the vote, we have the gold standard. As soon as women get the vote, we get rid of the gold standard. Now I know a lot of people support the gold standard, I don’t. I prefer democracy. But I would think hard currency and democracy are probably ultimately incompatible, so that’s the reason we have moved to soft currencies, to allow this form of wealth redistribution, and it’s savers who have to understand it more than anybody. And that’s primarily obviously the older generation who tend to have the savings.
Bill Fleckenstein:
I have a fellow that was my original mentor in the business, and what he used to say is in a social democracy, all roads lead to inflation, a variation of what you just said there. What do you-
Russell Napier:
Yeah. I think it’s [crosstalk 00:31:58] inflation that’s important Bill. Three, four, 5%, we can probably cope with that. The problem is, can we keep it at that level? Is there a government in history that managed to cap it at these levels? And the answer has been no.
Bill Fleckenstein:
What do you say to the people, people that are completely convinced that we’re on the path to deflation no matter what? I think one of the crucial elements of their argument is, there’s simply too much debt, and the debt is going to mean that we… there’s no way around the deflationary outcome. What do you say to those people that are in that camp?
Russell Napier:
Okay, well obviously for the last decade I’ve been arguing that we’re going to have deflation rather than inflation. And it wasn’t an argument that thee was too much debt. It was that there was too much debt, but not enough money. So that’s the equation. What’s the relationship between debt and money, and debt the GDP has been edging up? We solve the problem of debt if we can just create more money. And it was thought that central bankers would achieve that, and they’ve absolutely failed to achieve it. So the difference now is not that there’s any less debt. There’s more debt than ever. But finally, they found a way of creating more money, so it’s the money that does that.
Russell Napier:
There are a limited number of ways you can bring down your debt to GDP ratio, and inflation is probably the least painful, and that’s why it’s preferred. It’s preferred over default, it’s preferred over austerity, and that’s why it’s going to be inflation. And there’s a perfect model for this in post-World War II. We find ourselves, at least in the government sector, with similar debt to GDP ratios, and there is a model to how democracies dealt with it. So just because that’s the way they did it this time doesn’t guarantee that that’s the way they do it next time, but there is at least a nice historical model of how all of this is done. So it’s not a great surprise as to how you do it, because we’ve done it already.
Russell Napier:
In fact, policymakers I speak to, and I don’t speak to very many, point to the ‘45 to 1980 period as the triumph of government’s ability to reduce debt to GDP. And just to put into context for your viewers, what was that triumph like for savers? Well if you owned British government bonds, you lost 85% of your purchasing power. There are modern policymakers who believe that to be one of the greatest success stories in history.
Russell Napier:
Now, if you’re the state and you brought your debt to GDP ratio from 250% to 30%, yes. If you’re a saver, no. So it’s just all these different constituents in society. We’ve done it before. They see that as a model as to how we do it again, and inflation is that… it’s not an invisible tax, but it’s less visible than the normal taxation that is foisted upon people. And this one’s pretty clearly targeted on savers, and they are the guilty men aren’t they, and the guilty women? I hear every day how guilty they are for having savings.
Grant Williams:
Russell, you talked about this transition of kind of control over the outcome now from central banks to policymakers. And it was really interesting, because you talked about how central banks are basically… in fact have become irrelevant at this point. This has been something that we’ve debated backwards and forwards for decades literally, about this omnipresence and this omnipotence of central bankers. To have them rendered powerless almost by virtue of the stroke of a congressional pen, just talk a little bit about how important that is and why you see it that way. Because if you’re right, and I suspect you might well be, that is a huge change, both in the landscape and also how we have to think about what programs might be instituted next.
Russell Napier:
Yeah. So it’s the greatest irony that almost everybody I speak to believes that central bankers are all powerful just as they’ve lost all their power. [crosstalk 00:35:42]. And for those of you watching this who’ve seen The Wizard of Oz, that shouldn’t come as a great surprise, that scene of The Wizard of Oz. so I mentioned that this old way of creating money, or this way of creating money through commercial banks, and then what central banks do is create high powered money bank reserves, which sits in the banks. So imagine a world where you Grant are running the central reserve, and you’re in control of this money that goes into the banks, this form of money here. But I am the government, and I’m in control of the balance sheet, so I’m in control of whether that balance sheet expands or contracts, at the pace at which it expands and contracts. The person who’s creating money now is me, it’s not you. You can feed as many of these into the commercial banking system as you want, you can pull as many of these out of the commercial banking system as you want.
Russell Napier:
But if it’s me, the government, who says you guys are increasing your balance sheets by 20% this year, I’m in the business of making money. But you’re the one who’s got the 2% inflation target. Now, what are your chances of hitting that 2% inflation target when I control the supply of money? So that in my opinion is what’s happened. The people who push back against me say, “It’s only temporary. It’s a temporary move of the governments and the commercial banks. They’ll be out.” To stress, if that’s correct, I am wrong and the central bankers have not lost their power. But that’s how they have lost their power, and it’s global. It’s happening everywhere. You might call it capitalism with Chinese characteristics.
Grant Williams:
Yeah, this whole idea that they can do that, meet that inflation target with someone else flooding the system with money, it doesn’t take a lot of time to think it through to realize it’s just unworkable.
Russell Napier:
Yeah, and think of what the conclusions are for the Euro. I mean, if there are 19 member states of the Euro zone, if each 19 of the member states is in control of the creation of Euros, how long can you have a single currency? I think initially people will get very excited about their ability to create lots of Euros given how much the ECB has failed to so. But in the long run, you can’t have a single currency with 19 currency issuing member states. So the market hasn’t caught onto that yet, but that’s because everybody needs money, and therefore it’s just, we’re in the early stages of reflation. But the time will come when a company like Germany wants to stop, and doesn’t want to create more inflation, and doesn’t want to move money from savers to debtors, but countries like France or Italy are still very keen to keep going, and that’s when the schism comes and raises questions about a single currency.
Bill Fleckenstein:
What do you think the outcome will be in Japan, where… I’m sort of fascinated with this idea of, now that they’ve got control of essentially half the JGBs, what would you guess the end game is there? Are they going to just tear it up or swap it for something else, and what will life look like on the other side of that if they do something like that?
Russell Napier:
Okay, so we’ll start with one proposition, which I’ll give you for all central banks. The balance sheets will never shrink from current levels. I think that’s easy to agree with, I think we probably all agree. Now if that’s true, is anything they hold actually debt? Because it is a perpetual non-interest bearing transfer. And where I come from, we call that a gift. A perpetual non-interest bearing transfer, I mean even Goldman couldn’t sell a perpetual non-interest bearing transfer. Though I don’t know, maybe they could. So it’s not debt, it’s already [inaudible 00:39:21]. So you don’t say, “Will they ever tear it up,” you never have to tear that up. It’s already ceased to be debt.
Russell Napier:
Now I have some really high quality academic backing for that, because the Chicago plan of 1933, which had at least two economic geniuses on it in Frank Knight and Irving Fisher, called debt held by the central banks equity in the commonwealth. It ceased to be debt. So the answer to your question Bill is I think they can give up buying any more JGBs. I don’t think they really have to. Now that they’ve got control of the commercial banking system, it’s going to work much better anyway than just simply buying JGBs and flushing the banking system full of reserves. Why bother giving them more reserves? They’ve got reserves coming out of their ears. You could sink the Titanic with the reserves those guys have set up. So I think they can kind of lay up on that once they’ve got control of the commercial banks.
Russell Napier:
It’s really fascinating, the broad money growth in Japan is at 5.9%, which from memory is going to be a 30 year high, just like that. So all these years trying to create money, suddenly you wake up one morning and there’s money gushing out of the system. Are they really going to give it up and go back to buying even more JGBs? But the answer to your question, I think for every central banker in the world, is all the debt they hold is no longer debt. I think many people watching this will say, “Well if it’s that easy, why haven’t we been doing this forever?” And the reason is not because of the debt they held, it’s because of the reserves they created in the process. And historically, if you created too many reserves in the banking system, you got massive bank loan growth and money supply growth. But we got away with it this time, because all those reserves didn’t pile up in the system. So it creates many, many other problems.
Russell Napier:
I mean, I’ve argued for at least eight years of the QE period that the way this would end is that they would just go to controlling the commercial bank balance sheets, rather than ever try to shrink the reserves in the banking system. If you just said to the banks, “Guys, this year, 6% loan growth. No more, no less. 6% loan growth,” you wouldn’t have to worry that the central bank balance sheets were so big and the reserves in the system were so big. So I’ve argued long and hard that they would control it. I didn’t actually see them controlling it through bank credit guarantees, but anyway, this is where we’ve got to. They now are controlling.
Grant Williams:
So how similar is this, and how applicable is the example of Japan and the directed lending, how the Japanese banks were given quotas and said, “You will get this lending out the door into the economy every month, and you’ll report back to the Bank of Japan, and you have to meet these quotas,” essentially.
Russell Napier:
So the problem for Japan over the last 20 years is it really hasn’t had any bank credit growth, and therefore it hasn’t had any broad money growth, and that’s why they failed to get inflation. But that’s now begun to change. In the period of financial repression I mentioned before, that’s exactly what happened. The government would say every year to the banks, “Here’s how much you’re allowed to lend,” interestingly not because there wasn’t enough inflation, but actually the reverse. They were trying to cap bank credit growth and money supply growth, because there was too much of it. And even Richard Nixon was up to that. You can remember that it was Nixon who brought in price controls, and credit controls, and tightened up on capital controls. Republicans can do this just as easily as democrats in a crisis, when you get to a crisis.
Russell Napier:
So for most of the postwar period, commercial bank balance sheets were simply controlled not through interest rates. That was what the revolution was of the late 1970s, early ‘80s. It was to control things via interest rates, via the price, rather than via mandated government quantities. And what this bank credit guarantee program shows is the birth of a system of moving is back to government quotas and not prices, so that’s post-capitalist system. Just to be clear, the last 20 years hasn’t exactly been a capitalist system anyway, but this does eradicate some of the more capitalist elements of it.
Russell Napier:
And my best example of what that does in the long run, we’ve discussed some of the good things that can do for the average guy in the street in the short run. But in the long run, the United Kingdom used to have some of the world’s greatest automobile companies, but we went into financial repression with government mandated credit, and we ended up with British Leyland. Now I guess many people watching this won’t know what British Leyland is.
Grant Williams:
No, they won’t.
Russell Napier:
But you should Google it. And in my library of mistakes, which I run in Edinburgh pride of place, we have a British Leyland key fob sitting up on the mantelpiece. So government mandated credit flows, maybe even equity flows, do take you to a dark place eventually. But what I think is interesting about the great financial repression in the United Kingdom from ‘45 to ‘80, halfway through that, about ‘63, the prime minister of the United Kingdom was able to stand up in public and say, “You’ve never had it so good.” Because for a large portion of the population, that was true. That early inflation was quite good.
Grant Williams:
Yeah, and within a few years we were asking the IMF to bail us out as I remember.
Russell Napier:
Correct. I think from memory, 1976.
Grant Williams:
‘76, yeah.
Russell Napier:
14 years later, we were bankrupt, and it was because we’d allocated the capital so badly that we were inefficient and we couldn’t compete with anybody.
Grant Williams:
Yeah. You know Russell, something else you said in that conversation you said caught my eye, and that’s a kind of theme that we’ve had brought up on this podcast before. We were using it with the context of promoting people to run desks at the beginning of cycles who were young and inexperienced, and didn’t have the scars of previous cycles. And you mentioned almost as a throwaway at the end of your conversation at The Market, talking about how you’ve been recommending to clients that they promote people who’ve been running emerging market desks to run their developed markets desk, which is kind of the same thing. But I’d love you to kind of flesh that out a bit more, because it makes so much sense to me, so I’d just love to get your color on it.
Russell Napier:
Yeah, so the two elements of financial repression are, just to recap, higher inflation and holding interest rates down. And hopefully we’ve covered already a lot of the massive government interference actually you need to hold interest rates down, so it’s not that simple. Now I would argue if you’ve been managing money in emerging markets, you’ve kind of been coping with this for a very long period of time. This has been more the norm than the exception. The markets were never free, and inflation has been genuinely in emerging markets much higher. Political interference has been much higher, political corruption has been much higher, and you therefore have learned a skillset as to how to allocate capital in this country. I’m often more blunt than that comment Grant. I always just say fire everybody and hire Brazilians. If there’s anybody who can successfully push up the savings power of their savings while living in Brazil, that person deserves respect and admiration, and you should have more Brazilians on this program. That’s kind of what I’m saying.
Russell Napier:
So most emergency markets never really got fully away from financial repression. Clearly much further away than they were in the late 1970s, but never completely away from it. And China, absolutely not away from it. So there’s a skillset among emerging market investors. Most people who manage money in the developed world have done that over 40 years of disinflation, and 40 years of markets becoming more powerful than governments. Maybe not so much the last 10. So they believe this is the norm. I’m sure you know this great story about the fish swimming along one day, and the two young fish coming swimming towards him. And the old fish says to the fish, “Nice day, boys. How’s the water?” And the two young fish keep swimming. And one turns to the other and goes, “What the hell is water?” And if you’ve lived in a world of disinflation, and more markets and less government, that’s the water, and that’s the water that you swim in. And you believe that that is what always exists.
Russell Napier:
And there are people from emerging markets who know that sometimes you get something different, and they’ve got a skillset to cope with that, and that’s why I think we should seriously, seriously think about that. And the skillset you needed to manage money from 1945 to 1979 was very different than the skillset that followed.
Bill Fleckenstein:
You made the point in your interview that those folks that have had all their formative years from the ‘80s on don’t really understand financial repression, and hence some of the emerging market folks have a better understanding. But maybe for those people who have learned how the world works in the last 10 or 20 years, can you just give them a shorthand description of what financial repression means, what that slogan means and how it operates so they’ll understand?
Russell Napier:
Yeah. So I have a 90 minute presentation on this, so now we’re going to… I did 400 years in two minutes. Now we’re going to have to really, really get going. Where to start? Let’s take it really-
Bill Fleckenstein:
We can just do the Cliff’s Notes, you know.
Russell Napier:
Yeah, I know you guys have Cliff’s Notes. I’ve never been a big fan of Cliff’s Notes. I mean, that’s the biggest problem I have in my library in the states. People walk in and they say, “What’s the one I should read?” The human being always wants a shortcut. Look, I’ll just cut to what I think are the two or three biggest takeaways.
Grant Williams:
Hey, I’ll take the whole 90 minutes Russell, don’t worry about me.
Russell Napier:
Okay, well yeah. Maybe some other time. Capital controls. So I think sit down with your portfolio, and try to imagine what that means for individual businesses in the portfolio. Inflation above interest rates we’ve already discussed. Think of it company by company, equity by equity, and you’ll come to some profound conclusions about what… the stocks that would benefit from that are minuscule in market capitalization terms. If you get a 40 year trend in inflation, the winners are all disinflationary stocks that benefit from disinflation.
Russell Napier:
And, I would also look at Japan. The many things that have gone wrong in Japan, but it’s clearly not benefited from having high fixed costs in a world with low inflation, so higher inflation is going to be beneficiary. So read financial history I think is the only simple answer I can give to that. Read about the ‘45 to ‘79 period, read what worked, what didn’t work. There are still a few very old fund managers who were around then and speak to them. I’ve just brushed the surface, but that’s some kind of maybe pointers in the right direction for what financial repression, in practical terms where you should be looking and what you should be trying to do.
Russell Napier:
Gold is the standard asset for financial repression, and I’m not a gold bug. I’m not somebody who turns up every day and says buy gold, but for four years since I’ve been writing about financial repression, it is the standard asset to cope with that. And I don’t say that lightly, because it’s an unproductive asset. For anybody watching this who knows the parable of the talents, it’s the equivalent of taking the money from the master and digging a hole in the ground and putting it in there, and it’s not good for society. But when we get to a world of financial repression, I’m afraid that is, gold is the standard asset class.
Grant Williams:
Yeah, you’ve done the job beautifully for me, because I was going to come onto gold. Because it’s something obviously we haven’t really… we’ve mentioned it when we went back to 1695 and the coins, but we haven’t really talked about it. And it’s now become something that you really have to talk… it’s kind of forced its way into the conversation, whichever way you want to cut it. And when you talk about this idea of the experience that emerging market managers have, emerging market citizens have of dealing with financial repression, a big part of that is obviously a very loosely held faith in whatever currency they are presented with at any given time, and a much stronger faith in gold, because they’ve seen what it can do through periods of financial repression. So with the caveat that you are absolutely not a gold bug and it’s not something that you’ve talked about… I mean you’ve acknowledged its qualities, both good and bad over the years, talk a little bit about how your thinking around this seminal event you described has changed your thinking towards gold, and what that means for both gold and the people who haven’t been looking at it, but really perhaps ought to take a look at it now.
Russell Napier:
So I’ll start at the inflation bit, because I think it just goes without saying that more inflation’s going to be good for gold. That’s the bit I think everybody gets. And not everybody might agree with me that there’s inflation coming. It’s actually the other bit I think which is more powerful for gold. Remember, that second bit of this equation was keeping interest rates down while [inaudible 00:51:18] goes up. That means mandating where people can put their money. It means much more government control in the allocation of credit, it means the government trying to get money from savers, it means more administrative moves in those markets, it means some form of restriction on the free movement of capital. And therefore people go for that thing which can move freely across borders, which is more difficult, not impossible, but more difficult for government to interfere with.
Russell Napier:
So gold benefits from two things. It benefits from the higher inflation, but actually it benefits even more from the ability of governments through macroprudential regulation to interfere on the returns of paper assets. And interfering on the return on gold, there’s only one way to do that which is take it off you. But it’s so easy. I mean, if I wanted to interfere with the return on equity, it’s easy. I can double the corporate tax rate. If I want to interfere with the rate of returns on bonds as a government, I can do that easily by creating more inflation and forcing you to buy it. The only way I can interfere with the return on this stuff is to take it off you, which is not impossible but it’s unlikely.
Russell Napier:
So it’s more about the move back towards more government that is probably going to be ultimately more powerful. So the market’s [inaudible 00:52:30] inflation, I mean if we look at inflation with bonds at the minute, they’re not signaling there’s going to be high inflation, yet gold is going straight up. So it may be that gold is more responding to that greater level of government intervention at the minute than it is to higher inflation expectations. But believe me, if you get both of those firing at the same time, it’s got a lot further to go, and I think both of those will have to fire at the same time, because I can see no other stable answer to the excessive debt level. And that’s not a stable answer, it’s just the least unstable answer [inaudible 00:53:03].
Grant Williams:
Those expectations, they are starting to creep up, and this is something again we’ve discussed on this podcast. Have you seen anything in inflation expectations, whether it’s in the TIPS market or in break evens, that lead you to suggest that perhaps at the margin, and these things tend to move at the margin first, people are starting to cotton onto this? Because it seems to me that it’s starting to happen, but not in a meaningful way just yet.
Russell Napier:
Yeah. So I mean, [inaudible 00:53:33] is indicative inflation rates are up since the lows in March. But if I give you, and I must admit I’ve been fishing for a few days, Grant, so I haven’t been checking.
Grant Williams:
Good for you. Good for you.
Russell Napier:
I’ve been frightening trout or I’ve been frightening investors for the past… but if I give your viewers some idea where we are in those numbers, I mean I think the whole of Europe is still below 0.5% indicated inflation over the next five years, and certainly just a few weeks ago Italy was below 0.2%. Japan is in the same situation. America would be a bit higher. The United Kingdom is the one that’s significantly higher, South Africa is a little higher.
Russell Napier:
But they’re incredibly, maybe up from March, but they’re incredibly low levels. Some of those companies, France in particular, will be below where it was in 2009, which I think is pretty remarkable. Not every country is, but France is. So whatever the journey from March to the current is, we’re still running at incredibly low levels.
Russell Napier:
I could put it in another way. Most of these, maybe with the exception of Japan, most of the break even inflation rates are at levels of inflation over the next five years that none of these countries have never actually achieved, and that would be even Germany. I think even Germany would never have achieved the level of inflation which they’re expected to achieve over the next five years, so that maybe puts it into some context. Yes it’s up a little bit, but the idea that we’re breaking out on inflation expectations is not happening yet. So it’s interesting about gold, isn’t it? Gold, something else must be moving gold.
Grant Williams:
I keep thinking maybe it’s just currency, it’s just people looking at what’s happening here and thinking they’re just going to debase all these currencies and that seems to be the only option.
Bill Fleckenstein:
Well, another point is the central bank policies of the last 25 years have basically anesthetized the bond markets, because it’s not a real market. It’s an administered rate, to use whoever’s phrase coined that. And it may take longer, and plus with the muscle memory that’s been developed as you just sort of alluded to, it’s possible it’s going to take those markets that have been sort of administered and all the participants have learned the world as it has been to react, whereas gold is a non-administered market, it can do whatever the hell it wants. And maybe that’s the first place we’re seeing it, simply because it’s “free market.”
Russell Napier:
Yeah, I think that’s perfectly. And we already have in place certain mechanisms to hold these bond yields down through asset liability modeling and stuff like that, which is keeping them down. The only one I wouldn’t underestimate is the fact that somewhere even as we speak in the South China Seas, there’s a man called Admiral James Kirk who’s in control of two American aircraft carriers. I mean, that would make me want to hoard a little more gold as well. I mean, if the China/American relationship, which I hope and pray doesn’t become more than a cold war, is going in the wrong direction very, very quickly indeed. So the more American aircraft carriers get closer to China, I think the more the gold price also goes up. I mean, there’s no easy answer to this. This is a conflict foreign trade and capital and technology, and ultimately in armaments, hopefully just tidying them up against each other. So that’s going to send the gold price higher.
Bill Fleckenstein:
Well you know that development that you’re speaking of has really not gotten much sort of ink anywhere, about the friction on all three different levels. And because it seems like the mainstream media is so caught up in the societal virtue signaling things that are going on, but that is a real problem that has been growing. It’s a wildcard, but it’s a very big deal. And what would you think it would take to have people start focusing on that more, just the first skirmish? We really don’t want a skirmish, that would be really bad.
Russell Napier:
I don’t think it’s going to be a skirmish, but what I think is going to happen, America has left the intermediate range nuclear missile treaty with Russia. They didn’t leave that treaty to build more missiles to face down Russia, it left that treaty so it can build missiles to face down China, and that is in no doubt whatsoever. Now from memory, the intermediate range missile’s only about 3,000 miles, so what’s intermediate to some people sounds like quite a long way for us. But that means that there is nowhere for those missiles to go except somewhere in Asia. There has to be a country in Asia that’s going to accept these missiles.
Russell Napier:
And it’s not as if it’s a secret that the American defense minister spends his time trying to find governments in Asia that will accept these missiles, and I think somebody eventually will. And I would say that’s what’s going to focus the mind. Now there, was an announcement from Australia last week in terms of formally contesting China’s claims to the South China Sea, which could be a precursor to Australia accepting these missiles. Out of left field, it’s not beyond the realms of possibility that it’s Vietnam that accepts these missiles, despite that horrible history between Vietnam and the United States of America.
Russell Napier:
So my answer to your question is, I do really hope it’s not a skirmish, but I think once these American missiles start arriving, that’s the Cuban Missile Crisis in reverse. They won’t have… well they shouldn’t have nuclear warheads on them, but for China, this is the Cuban moment, and the tensions there will rise dramatically. So that may not be a skirmish, but it’s still pretty frightening and it’s still pretty scary, because so far, China has not… China, as you know it’s been let’s say silently aggressive for a long time here.
Russell Napier:
But in terms of the punches that the president’s been landing on it, it’s been on the ropes with its hands up. It doesn’t want to come out and punch, because it’s hoping that President Trump goes away. It’s a bit like the rumble in the jungle, right? So they’re kind of hoping that that’ll happen. But I don’t think that the democrats will actually be any less… I think they’ll be just as strong after China as the republicans are. So at some stage, China’s going to have to come out punching rather than just sitting on the ropes hoping that they go away, and coming out punching is definitely going to have to happen if missiles start appearing around China. So I think that will be the trigger point. It could be tomorrow morning. It could be tomorrow morning, and it might not be for two years. I don’t think anybody who’s watching this can really get the insight to know which Asian country will first accept these missiles. The balance of power starts changing dramatically as they start coming in.
Grant Williams:
Russell, just before we wrap it up, I’d love to get your views on the economy. Obviously we’ve seen all this V shaped stuff being necessarily almost trotted out, because that’s the thing that we all have to believe is that there is a V shaped recovery underway. I mean, Larry Kudlow, God bless him. I don’t know how he does it, but he seems to be able to get up and say this stuff with a straight face. But what do you see? Because it seems completely unfeasible for me for the economy to get back anywhere near where it was. And if that’s correct, then there are an awful lot of asset prices in this world which are priced utterly incorrectly.
Russell Napier:
Yeah, so I mean obviously that’s the big guesswork. And I don’t think there’s much worth talking about velocity, because kind of velocity’s a product of GDP anyway. My guess, I’d say we take 18 months to get back to where we were in January, but that seems to be rather inflationary if it’s only 18 months. If the savings rate comes back to where it was in January in 18 months, and therefore spending goes back to where it was in 18 months, and the total amount of money in the system’s at least 15% higher, then how outrageous is it to have 4% inflation? And I guess I can’t in any way back up the 18 months. Some people might say it’s five years before it happens, but I’m looking at something like SARS in Hong Kong as something of a guide, or SARS in China as something of a guide, and within 18 months we get on with it.
Russell Napier:
And it depends when you think what human beings are, and I have this incredible faith in human beings to revert… well, faith and also dismay that they revert to normal behavior. It’s a combination of both. But think of what human beings have been through. I mean, the Blitz in London, SARS, pandemics, whatever. But underneath it, they want to revert to the way they were before. And on the whole, they achieve it, and they achieve it more quickly than you’d think, so that’s not a V shaped recovery. But I think within 18 months life will be going on. It won’t be going on the same for certain businesses for sure. There’ll be certain businesses [inaudible 01:02:08] and will not be coming back, and behavior will change. But in terms of consumption relative to savings, which is really I think what we’re most focused on, I think it will come back to roughly where it was in January within 18 months.
Russell Napier:
So the savings rate I think has just come down from 32% to the high 20s. It was probably seven when we started this. It’s not outrageous to say it goes back to seven. I don’t think we’re looking at a permanently higher jump in savings, and therefore I think within that timeframe it’ll be… in terms of the amount of money circulating in the economy and the speed at which it circulates, it will be normal within 18 months. We’re already, what, five months into that? So that’s 13 months from now.
Grant Williams:
And you were talking about 4% inflation likely to be a reality by 2021. Obviously I never hold anyone to any timeframes, because we’re all just guessing about the future. But it’s interesting that your window for this to pick up to that kind of degree is so relatively short. A lot of people are saying this is a four or five year problem, but you’re talking within 12 to 18 months.
Russell Napier:
I mean, I said actually 2020. And I don’t usually give such a timeframe, but I just thought it would be dishonest of me to make a claim for more inflation without putting some [inaudible 01:03:22] on it. So on this occasion, I’ve said 4% or higher sometime in 2020 across the developed world. There is a reason for that, which has nothing to do with money, which is I do think this China thing’s getting out of control. And if we are in a world where we’re abled to divest from China, that’s also highly inflationary. Not in everything, some things it’s actually deflationary, in perhaps commodities. So if you have a belief that we’re going that direction with China and we’re looking at broad money growth, my opinion, stabilizing it above 15%. It seems to be inconsistent to say that there wouldn’t be a level of reflation around 4%, and 4% isn’t a high number. Actually it’s a fairly low number, but it is interesting that I can’t persuade people that it will even get to 4%.
Russell Napier:
But China is part of that equation for higher inflation. It’s clearly been a massive disinflationary force, and if we begin to take it out of the global trading regime, that adds to the inflation.
Bill Fleckenstein:
Well on the subject of inflation, I mean logically what you suggest doesn’t seem to be a stretch at all. One question I have that’s puzzled me for a long time is, when you said sort of worldwide, one of the problems is the inflation measurement issue. Here in the states of course we have the CPI, which has been particularly bastardized such that it’s extremely difficult to show inflation when you can use hedonics and substitution and those other tricks. I don’t know how the statistics are calculated in all these other countries. So do you kind of mean it’d be a generally accepted view that that’s about what it’s running at, even though the data may not show that? Because to get the CPI to print four, I think inflation itself would probably have to be 10 or 12, because it’s such a bad measure.
Russell Napier:
No, I think we can get the measured CPI at four. And I haven’t looked at John Williams who runs shadow statistics [crosstalk 01:05:12]-
Bill Fleckenstein:
Right, I’m familiar with his work.
Russell Napier:
I haven’t looked at them recently. No, I think the actual reported number can be at four. Four isn’t outrageous. We were close to four in 2007, I think we may have got just to four. I think we were close to four in 2011, we were at four in 2000, we were at four in ‘96. Four, I’ve got a long presentation on why four’s an important number. But the reason I picked that period is those were periods of China producing, those were periods of massive technological breakthrough, and those were periods where money supply growth was probably closer to 10 than five, and even then you got to 4%. So it’s not an outrageous forecast to say four, and that was on the measured number. And the hedonics came in in about 1990, so Clinton’s administration, they had done hedonic adjustments. So even with hedonic adjustments, even with these great structural disinflationary trends, we’ve still been able to get inflation to 4% with the right level of money. So I don’t think it’s… I think it’s a fairly straightforward forecast. The more difficult forecast is where it goes after that. That’s much more difficult, obviously it can get out of control.
Grant Williams:
Well I was going to say, most times 4% is a stop on the way to double digits or one. It’s not normally somewhere it goes and stays.
Russell Napier:
Well that’s been the fascinating thing. It’s really why… I mean obviously I’ve been wrong on a lot of things, that’s the business you’re in when you forecast. And on four occasions in my career, inflation has gotten to 4% and stopped. That’s US inflation, and that’s been the thing that’s surprised me, when it’s stopped. And I’m making them up, but I think those four I mentioned, ‘96, 2000, 2007, and 2011, and it stopped and it came back down again. And that’s probably, back to Bill’s comment, why are people so complacent about this, that’s probably the other reason is that whether it was by the design of the fed or pure luck, it stopped at four last time. I don’t think it will this time, but I haven’t actually written a piece of research to focus on that, because it’s hard enough persuading people it’s going to four.
Grant Williams:
Right.
Bill Fleckenstein:
Right.
Russell Napier:
I think back to your point Grant, I think that’s a fairly unique period of history in a fiat currency where we’ve actually been able to constantly stop it at four. That’s been an achievement of sorts. It’s come at a very, very high price if you ask me, but-
Bill Fleckenstein:
We had two bubbles that burst each time to help get it back down to four. That’s a rather big accident that helped out.
Russell Napier:
That’s what I mean, it’s come at a very high price, but the market maybe believes, hey it was genius, we can cap it at four, they’ve capped it at four before. And through that entire period, we just added more and more and more debt, meaning that we have to really really inflate it away, and that’s the high price we ultimately pay. We’ve stopped it by getting even more debt onboard, so maybe that’s why. People think, “Well, it could go up, but it can’t go through four, because it’s never gone through four in my lifetime,” meaning they’re very young.
Grant Williams:
Yeah, exactly right. Well look Russell, we’ve taken up plenty of your time. Before we go, I know there are thousands of people out there who follow everything you do, and they know how to get ahold of you and they know all about the Library of Mistakes, and they know all about all the good stuff you’ve done. But there will be people listening to this who aren’t familiar, so perhaps you could tell them how they can follow you more, and give a little plug to the Library of Mistakes, because I’m dying to come see it next time I get to Edinburgh.
Russell Napier:
Yeah, so there’s kind of bad news on that first bit, because I do write for ERIC, my website, but you’re only allowed into ERIC if you work for a regulated financial institution, so there you have it. There is the bad news. That’s just under British law. The good news is that lots of people steal it and it appears all over the place. Using Google and the year 2020, it’s amazing where it seems to crop up, and one day we shall pursue these vagabonds and deal with them. But at the minute, they are stealing it, so some of it will crop up. But if you do work for a regulated financial institution, please go to… put my name and the word ERIC and you’ll find where to register online.
Russell Napier:
In terms of the Library of Mistakes, we now have two open, and a third one would be open if it wasn’t for COVID. So I don’t know if you’re a regular visitor to Switzerland, Grant, to go and look around.
Grant Williams:
Never heard of it.
Russell Napier:
Yeah, okay. So you don’t go to Switzerland, but if you ever happen to go to Switzerland, Lausanne, we’ll be opening one in Lausanne very soon. I wish it was open, but it’s a beautiful library. There’s one in Pune India, and there’s one in Edinburgh. It’s a charity, these are charitable ventures. They’re open to the general public, you just have to go and register. On the Edinburgh one, we run guest lectures and we record those for short excerpts of those, so if you go to the Edinburgh one and click on lectures, you’ll find lots of little lectures on financial history which we hope are instructive to help you forecast the financial future. And if anybody’s looking to set up a Library of Mistakes, we’re happy to collaborate with you. All you need is enthusiasm and a large checkbook. So if there’s anybody watching this who has both of those assets, we’d be delighted to have a conversation with you, and we can open a few more of these. I’m beginning to educate the public, and more importantly the investing professionals that the future cannot be described in an equation.
Grant Williams:
Yeah, amen to that.
Bill Fleckenstein:
Well said.
Grant Williams:
And with inflation coming, what better use to get rid of all that currency in your pocket but helping fund another Library of Mistakes. Think it’s a great way to save yourself the pain of inflation.
Russell Napier:
I would say cash in all your paper and help us buy more paper.
Grant Williams:
There you go, exactly right. Russell, thank you so much for doing this. It’s been a pleasure, as it always is whenever I get to talk to you, and thanks for being so gracious with your time.
Russell Napier:
Okay, not a problem. Thanks a lot.
Grant Williams:
Take care, bye bye.
Bill Fleckenstein:
Wow, that’s going to blow some people’s minds.
Grant Williams:
Fascinating, right?
Bill Fleckenstein:
Swear to God. I mean, I believe everything he said. He just articulated it better than I could.
Grant Williams:
Yeah, Russell’s one of a kind. He writes beautifully, he speaks beautifully. And as I said to you before, before we started recording, I said Russell’s knowledge of history is just unparalleled. So imagine my delight when he said, “I’m going to go back to 1695 to tell that story.” I’m like, that’s my boy. But he’s amazing.
Bill Fleckenstein:
It was rather remarkable how he got from 1695 to the present so quickly.
Grant Williams:
Yeah, right? But as I said at the time, it just shows you how little has changed, right? Underneath all this, they changed the color of the buttons and they changed the handles on the levers, but the principles are the same. I mean, it’s the same scheme run over and over again.
Bill Fleckenstein:
Well, and I thought about the point that Mike Green made about, the game you’re playing may not be the game that’s actually in operation, and what he basically was saying was that… he’d said it differently, but the game everyone’s playing is maybe going to change to something else that you have to have a lot of gray hair to have seen already once.
Grant Williams:
Well, I think for both of us that’s a big reason for doing this podcast, is to get people in the space where they’re thinking about this stuff and they’re thinking about… because it’s so easy to be complacent and assume that the rules of the game never change, but they do. One day they put a three point arc on the NBA court, right? And the game changed completely.
Bill Fleckenstein:
Right.
Grant Williams:
So that’s I think the best gift we can give people with these conversations, is just listening to people who do think both through the lens of the past, and more importantly perhaps, into the lens of the future, just how things could change. And don’t be complacent and assume that the rules by which you play the game today are going to be the same tomorrow, because they won’t. And necessarily I think, with the problems that we face, those rule changes will have to be put in very fast and be Draconian. Because if people get a whiff that the rules of the game are going to change and start to plan and position accordingly, it kind of negates the reasons for changing the rules in the first place.
Bill Fleckenstein:
Well said. The old Bernard Baruch quote, I think it was Bernard Baruch, or maybe it was Jessie Livermore. And I probably read it because of Jim Grant-
Grant Williams:
Yeah, [crosstalk 01:13:01].
Bill Fleckenstein:
But, hold still little guppy, or little fish, the gutting won’t hurt much. Move along, or something like that.
Grant Williams:
Oh boy.
Bill Fleckenstein:
I think I mangled it.
Grant Williams:
Well look, another episode in The End Game series in the books. We have our next guest lined up, and it’s going to be another barn burner of a conversation. We’ve been so lucky in getting so many people who are just the right people to talk about this. And I won’t reveal who our next guest is, I want to make sure that the spotlight in this episode is firmly placed on Russell, but we do have another one of these things lined up, and-
Bill Fleckenstein:
Well, it’ll be probably the perfect counterpoint to this conversation. I mean, we didn’t exactly set it up that way, but that’s the way it’s going to come down. And so it’ll be interesting to see… one thing, a point I wanted to make about what you were saying a minute ago is that the beauty of being able to talk to somebody over an hour say, you can actually get the logic, and their premises, and how they feel about things all sorted out. It’s almost impossible to ever get that done on TV, so most of the financial news programs could never, ever even attempt to get at some of these issues. This is about the only medium where you could do it.
Grant Williams:
That’s so true.
Bill Fleckenstein:
I’m not saying us…
Grant Williams:
I know.
Bill Fleckenstein:
I’m saying a podcast.
Grant Williams:
No, your point’s well taken. And that was hammered home to me as we talked to Jim on the last episode, because Jim is a regular on all kinds of programming on the networks, and none of these idiots ever give him a chance to talk. And it’s like, why wouldn’t you just shut up if you can listen to Jim Grant speak? There is literally nothing I have ever said or will ever say that is more interesting to me or anybody else than listening to Jim Grant speak, so shut up. It’s simple.
Bill Fleckenstein:
Well, what he has to say doesn’t fit their narrative.
Grant Williams:
Well, that’s true.
Bill Fleckenstein:
To use the modern vernacular.
Grant Williams:
Yeah, that’s true. That is true. Anyway mate, that’s it for another episode. Thank you so much for tuning in and joining us. If you could, I ask this every time, but if you could find a second to rate and review us on iTunes, it really does help. It helps more people find the podcast and listen to the likes of Jim and Russell and all the other fantastic guests we’ve had on. You can follow me on Twitter should you have the inclination to do so @ttmygh.
Bill Fleckenstein:
And you can find me @fleckcap, as it sounds, or you could go to my website, fleckensteincapital.com.
Grant Williams:
You can do both, and I would recommend you do both. Bill, thanks mate. We’ll do this again soon. Very soon in fact, couple of days.
Bill Fleckenstein:
Yeah. I look forward to it mate.
Grant Williams:
All right, take care.
Bill Fleckenstein:
See you.
Grant Williams:
Nothing we discuss during The End Game should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets.
