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 transcript
Algy 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....
