From CityWire, April 3:
Russell Napier believes a new financial system is taking shape based on the covert control of commercial banks by governments. This could channel huge amounts of capital to renewables.
The energy transition will require a lot of capital investment. Professor Russell Napier’s belief that governments are taking covert control of the money supply through interventions in the commercial banking sector – most recently at regional US banks and Credit Suisse – suggests a route through which lots of cheap capital may come.
His predictions, which are based on historical precedent, also offer a fascinating take on where the financial system in developed economies may be headed.
Russell is an acclaimed financial historian and market strategist. He writes the Solid Ground newsletter covering his global macroeconomic views. And he’s the co-founder and keeper of the Library of Mistakes, a library and reading room in Edinburgh devoted to the study of financial history and associated mishaps. He’s the host of the Library’s podcast, too.
Books mentioned in this podcast include two written by Napier – The Anatomy of a Bear and The Asian Financial Crisis – as well as Controlling Credit by Eric Monnet, and Capital Returns and Capital Account, both edited by Edward Chancellor. The Bank of England article mentioned can be found here.
Podcast transcriptAlgy Hall (host) - Hello and welcome to the Fix the Future Show. The podcast where we look at how investors can do good, while also making good returns. I’m Algy Hall, the investment editor of Fix the Future and I’m joined today, by Professor Russell Napier.
Russell is an acclaimed financial historian and market strategist. He writes the Solid Grand newsletter, in which he shares his global macro thinking, with a readership of mainly professional investors. He’s also the co-founder and keeper of the Library of Mistakes. A library and reading room devoted to the study of financial history and associated mishaps. He’s the host of the libraries podcast too and Russell is also the author two books. The Anatomy of a Bear, a fascinating study of four bear markets and more recently, The Asian Financial Crisis, 1995-1998, the Birth of the Age of Debt.
Hello, Russell.
Russell Napier (guest) - Hello.
Algy Hall - So, Russell, if we start, your book, The Asian Financial Crisis was, I think, originally meant to the be first chapter in a book intended to take us to the pivotal moment that you believe we’ve arrived at today. There’s clearly a lot of say about that history, seeing as a chapter turned into an entire book. If you can, could you give a brief outline of what you believe has been happening to the financial system since 1995, before we get on to how that may shape the future?
Russell Napier - The reason it’s relevant is that the defining fact in the world today is debt. Levels of debt relative to the size of the economy, relative to the size of private sector cashflow. So that book tries to get to the point of, why are we here? How did we get here and then we’ll spend a lot of time talking about where we go next. The fundamental reason we got here was a target for central banks of inflation, not credit. So, they ignored the build-up in credit in the system. In the book, it specifically says it was the devaluation of the renminbi in 1994 which triggered massive devaluations across Asia. Then, the crucial decision they all made, which was to lock in those incredibly cheap exchange rates.
Two consequences from that. One, they became rather large buyers of US Treasuries. So, they depressed what we refer to usually, as the global risk-free rate and secondly, by having grossly undervalued exchange rates, they exported deflation to the rest of the world and kept inflation low. So, if you lived in the developed world post these devaluations, you got remarkably low interest rates, partially due to the Asian central banks buying off fixed interest securities and you got very low inflation. So, you got the perfect opportunity to borrow more money and we did. So yes, a mistake by central bankers, but actually this bigger structural issue.
We created a whole new monetary system in 1994 to 1997 and didn’t really notice it, didn’t pay any attention to it. I think Paul Volcker, he had long left office, would talk about this as the non-system. He would call it the non-system and just how dangerous it was that there was no agreement here. This was imposed, it wasn’t agreed by all the parties and I think we’re living with the consequences. The consequence is that we have the highest level of debt of GDP, in the developed world ever recorded in human history. We don’t have all the data, as you know, for the whole of human history, but it’s certainly above World War II levels, when we add the government and the private sector together.
Therefore, almost certainly is the highest level of debt to GDP ever recorded and that is the number one thing that must shape all of our futures. Sustainable, unsustainable, whatever. That’s the starting point that we now have to begin to cope with. Just one final point on that. This thing, it didn’t just push interest rates to low levels, it pushed them to 5,000-year lows. At least we have interest rate history going back to the Sumerian period. So, let’s just say, all-time lows. So all-time high debt relative to the economy. Also, relative I think, to cash flow, certainly at current interest rates and all-time low interest rates and it’s over. The low interest rate bit is over. So now, we’ve got to work out what happens next, but I think that’s what the book is about. It’s about how we got where we are, but I think people are now more interested in where we’re going.
Algy Hall - Absolutely. Also, we’ve had this system which wasn’t an agreed regime, you said, but it was a system that carried on. We had low inflation through that time. What’s changed?
Russell Napier - Anybody listening to this, should really now go to the Bank of England website and read a little article I wrote called How Money is Made. I think’s compulsory reading for everybody. When you do that, what you discover is that nearly all the money in the world is made by commercial bankers. It is not made by the government and it is not made by the central bankers. That comes as a shock to most people. Even people with a great deal of experience in financial markets, it comes as a shock. So, if we fail to produce enough money to produce inflation, it has been, in recent years anyway, due to a lack of bank credit growth.
After the GFC, not only were the bank balance sheets in a mess, we did regulate them pretty heavily as well. So, the banks were not in the business of extending credit and creating money. Then one morning, I’m going to get to April 2020 everything changed because somewhere in government, somebody realised that you could make the banks lend as much money as you wanted them to lend if you guaranteed their credit risk. Now this is obviously, Covid. We basically closed down the economy. The private sector, households and corporates were desperately in need of money and the governments, obviously, used fiscal policy. More importantly, they used the banks and they guaranteed lots of bank lending and we’re paying for that now, as taxpayers, there were billions of pounds worth in this country, of defaulting corporations that we’re paying for as taxpayers.
So suddenly, the government’s realised something. There is a magic money tree. If we look at government debt to GDP one would say they’re completely tapped out, they couldn’t possibly borrow any money, but this is a contingent liability. It’s not directly on their balance sheet. They guarantee bank credit, the banks lend money and this was the problem and why we’ve got such high inflation. They lent so much money, the created so much money, we have inflation. To put it into context, if you’re in the US, it’s now over 40% of all the dollars ever created in history have been created since the start of Covid. It’s quite an impressive number and then all the central banks are all scratching their heads and saying, why do we have inflation?
That’s why we have inflation, but I blame the central banks a little bit. Remember, the governments basically, forced commercial banks to lend and this is important. The governments are in monetary policy, it’s always easy to say the governments do fiscal, the central bankers do monetary. We witnessing this in the last couple of weeks, the more the governments get involved in the banking system, the more the governments are in the monetary policy business. So if I had to blame anybody for this surge in inflation, I think I’d put it more to government, actually, than central bankers.
Algy Hall - Also, in terms of this back door route into monetary policy for governments. It’s been rediscovered hasn’t it. There are historical precedents for this.
Russell Napier - That’s an excellent point because really, for the whole of the post World War II period, this is how monetary policy was run and we didn’t really have independent central banks. Certainly not in Europe, we absolutely did not have them. You may be old enough to remember this great quote, ‘That the monetary policy of the United Kingdom was run by the Bank of England governor’s eyebrow.’ It was said that the Bank of England governor just had to raise his eyebrow to control monetary policy and of course, that’s correct. That is exactly how it works. In this period, if the government can control the growth of bank credit directly, it doesn’t need interest rates to do so.
That’s not the way monetary policy works. It works through a policy called credit control and if bank credit is directly linked to the supply of money, if the governor of the Bank of England said to you, run the United Kingdom’s biggest bank, I want you to grow your balance sheet at 10% this year and you’re at 10% by October, well he might call you into his office or her office these days and raise his eyebrow. That’s what that statement actually means. So, you’re absolutely right, for a very long period of time, this was the status quo. There is a very good book on it by a French academic called Eric Monnet, called ‘Controlling Credit’ which is a history of the post World War II French banking system.
Which may sound like the world’s most boring book after my own, but actually, if you want to know how the system works read the book and then ask yourself the question, who is the monetary authority of the United Kingdom? Is it the central bank still or is it the government? If you ask yourself the question in the context of what we already know about 1945 to 1979, you might come to a radically different answer from the one that you get from reading the front page of the Financial Times.
Algy Hall - What are the options that potentially we have, as being in the new world as being a very indebted country....
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