Financial repression is coming to Europe and the people that can’t see that don’t have a strong understanding of financial history and the lengths that politicians will go to get re-elected.
That’s the view of financial historian and strategist Russell Napier, who thinks that the failure of central banks to reflate the global financial system will lead to stronger and more significant government action.
Napier is the co-founder of online research platform ERIC and the author of Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms. In an interview with Real Vision TV, he envisions a sharp change in momentum from governments, starting with Europe, which is in a clear state of policy paralysis. Items on the policy menu include capital controls, dividend controls and the forced purchase of government debt.
Manipulated by the System with a Deluge of Monetary Policy
While professional investors have learned how to play the game against central bankers, who are not too dissimilar to investors themselves – being forward looking and focused on inflation – Napier said they have been “royally gamed by the financial system” on a diet of monetary policy, more monetary policy, and more monetary policy.
“But if it switches to government, then I think it’s a completely different game,” he said. “We’ve seen a little bit of it already in terms of government action, regulation, forcing people to buy that debt. But primarily, that debt’s been bought by central bankers,” he said.
It’s clear now that central banking isn’t working in terms of reflating the economy and its failure to produce nominal GDP growth above the growth in debt, is now leading some to believe that a fiscal solution is coming. But if people are getting excited about that, then Napier thinks they couldn’t be more wrong.
Fiscal Expansion Comes with Dangerous Baggage — The Tools of Financial Repression
“The nine most dangerous words in the English language are: ‘We’re from the government and we’re here to help you,'” he told Real Vision. “So to me it’s bizarre that people who are the stewards of other people’s capital are getting really excited because the government is coming,” adding that a fiscal expansion is likely to come with a lot of dangerous baggage.
These are the tools of financial repression and Napier said the first thing to understand about the government is that they don’t give up, they want to get re-elected and they will come back with something else. And once you go down the rabbit hole of financial repression then one control eventually leads to another.
It all starts with keeping the yield curve below inflation, which is easy enough for investors who will simply not buy any bonds, but that of course will encourage borrowing, which is what the government is trying to discourage, Napier says.
“So they have to bring in other things, measures, to stop you and I gearing up, which is the elements of financial repression. They have to try and force you and I to buy government debt even though it is a virtually guaranteed loss-making proposition, and they have to bring in controls that would stop us behaving naturally as a response to negative real interest rates. Now, those historically have been some horrific things.”
Federal Reserve Chair Janet Yellen
Who’s Going to Buy the Government Debt? You Are!
While the first main tool of financial repression has to be capital controls, Napier said it won’t just stop there, with dividend controls and higher corporate profits among the tactics designed to make other investments look less attractive, relative to government debt
“A lot of people think central bankers will keep going forever, but if we ever go to inflation, they clearly have to stop expanding their balance sheet, but somebody has to buy the government debt,” he said. “So let’s say the fiscal policy comes. It succeeds. We get growth. We get inflation. Central bank balance sheets cannot expand in the growth and inflation. So who’s going to buy the government debt? The answer is you are. Particularly if you work for a regulated financial institution. It’s much better if you’re an individual. But regulated financial institutions are the people who will be expected to do that, and that is financial repression.”
The Focus is Productive Growth — Not Speculative Growth
Over the past thirty years, it’s been an easy job for investors to buy an asset, gear up and wait for the profits, but not necessarily in an era where debt is supposed to grow more slowly than GDP and Napier said it is clear there will need to be a period of adjustment where the flow of credit needs to be controlled. “It has to go to what they will define as productive, not speculative,” he said. “And I think Theresa May may have already used that phrase.
“So we could be looking at a prolonged period of re-equitization of the whole financial system. It would happen tomorrow morning on the passage of one piece of legislation. The government bans the ability to deduct interest in the computation of corporation tax.
“Instantly, you’ve got a huge change. Now, do you think asset prices would go up in that environment? It seems to me that that policy, actually, would be a prime policy for financial repression. And I think if you take a longer term view– if you look at the structure of what we’ve built, it wouldn’t be a bad thing in the long term. You’d have to phase it in slowly.”
Europe is the Battleground for Financial Repression
The economic and political problems in Europe are well documented and this is where we could see the start of financial repression, Napier contends. In fact, its already been introduced twice with two countries having exchange controls imposed on them in the single currency block.
“Everything’s possible. And the political justifications are Europe is going through a major reconsideration of its constitutional relationship. It’s deciding whether it’s going to have fiscal integration or not fiscal integration,” Napier said. “Now, against the background of that we can’t have the financial professionals front-running all of that.”
No one really cares about the call for capital controls when it’s happening in places like Greece and Cyprus, he adds, but if it happens in one market where people have significant liquid assets, then that changes everything.
That is the crucial thing about the global impact of this,” Napier said, “If you de-liquify a major asset class– which is what a capital control does. It’s a de-liquefication event. As we know from financial history, that can be a solvency event for somebody. So that’s why I think it’s important.
“You have to rank things by their probability and their importance. I think this is probable, and I think it changes the 21st century,” he said, adding that when he speaks to investment managers about it, they just want him to phone them up the day before it happens, which sums up the problem as far as he is concerned. “We have to ride this to the end,” Napier said. “I think if you’re a steward of other people’s money and savings and their savings for their pensions and their retirement, you don’t get to leave the party at one minute to midnight.”
It all Comes Down to Financial History
What it all boils down to is a lack of understanding and appreciation of financial history, which isn’t taught in business school, but it’s a subject close to Napier’s heart, which he has written and taught about at length. He’s even opened a library in Edinburgh, dedicated to financial history, called ‘The Library of Mistakes’.
“They just don’t get it. They can’t cope with it. They don’t want to analyse it. They don’t want to talk about it. As far as they’re concerned, I’ll just buy good companies. I’ll stick with good companies. Everything will be fine. That will be what I’ll do,” he said.
“Now, that didn’t work out so well in the great financial crisis. Nothing to do with politicians, but to do with more not understanding money and credit. But this time, they don’t want to get to grips with the politicians.”
With Europe now in the process of potentially dissolving the euro for political reasons – nothing to do with economics and finance, which Napier said should have meant it would have been falling apart for years – it really highlights that politicians have been prepared to bend just about every rule to make it work
“Clearly if you’ve read a bit of financial history, you can’t forecast with 100 degree accuracy. But politicians may ultimately be more forecast-able than the prices you’re trying to forecast every day,” he said.
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