Russel Napier

The time has come for an extreme forecast of Monetary Restructuring, and the reason for that is DEBT. The global debt (Government debt + Non-Financial Corporate Debt + Consumer Debt) to GDP has reached an all-time high, and that is when interest rates touched a 5,000-year low (reached in the summer of 2020).

The beginning of debt crisis started when the link of the currencies to gold was broken in 1971, and there was no check on the creation of fiat currency. In the 1980s, it grew due to Michael Milken, who showed that debt did not necessarily have to come from the banking system, and he developed the bond market through mutual funds, pension funds, etc. Credit has not grown much in the last few years - non-bank credit has exploded. Since 2007, we have been trying to postpone the inevitable, but now it has come to the stage where a new Monetary System would have to be developed as inflation is now stubborn.

The debasement of currency has mostly been a way out of a Monetary crisis, except after the Napoleonic War, when the Pound Sterling was in trouble because of the debt that had grown to fight the war. Instead of devaluing the currency, the UK invaded other countries and stole their wealth. That is not possible now. Default is not also an option. Lehman defaulted, and that did not work out well. One hundred years ago, Argentina had one of the highest per capita incomes in the world - but since then, the country has defaulted four times and is still in trouble. Greece defaulted and is still not doing well because it could not really debase its currency as it was on the Euro.

DEBT CRISIS

THERE ARE THREE WAYS THAT THE DEBT CRISIS CAN BE RESTORED:


  • The interest rate will have to be higher than inflation. That will slow down the economy (or cause a Recession), although inflation will fall. However, especially in an election year, this is not likely to happen in the US. In fact, they are talking about cutting interest rates.
  • Austerity and devaluing the currency - Difficult to happen when democratic Governments depend on votes.

    Liz Truss's government fell because of her unfunded budget, sinking the pound, sending interest rates soaring to 4.5%, and forcing the Bank of England to prop up failing pension funds. She was gone in four weeks.

  • Financial Repression - This is when Central Banks have a reduced role, and Governments direct where the funding should go through the banking system and at what cost (interest rates). This is what is more likely to happen to reduce total debt. Normally, Financial Repression comes in a wartime situation, but this time, it is going to be more long drawn out as it will come country by country and little by little - so we are looking at a decade of volatility and increasing Financial Repression Japan cannot have rising inflation and keep the interest rates low - that is unsustainable. Another possibility is to allow the Japanese Government Bonds to fall and the interest rates to rise. Hedge funds are betting on that happening, and so are short Japanese Government Bonds. However, that is dangerous as it would result in huge losses for the banks holding government bonds (as happened with Silicon Valley Bank). The Japanese Central Bank would also suffer massive capital loss if this happened. The third alternative is forcing Institutions to buy Japanese bonds (Financial Repression) - anywhere else in the world that would be regulated, but moral persuasion works in Japan. To be able to finance this, they would have to sell other countries' government bonds, and that would have consequences as constant selling would put pressure on bond prices. Japanese are savers, and they would also have to invest abroad and return to their home country.

    Already, governments have started financial repression by guaranteeing certain loans that banks lend. This is happening more in Europe. This was prevalent after World War II, especially when rebuilding Europe. The amount of money in circulation was controlled by the amount of bank credit and the government directing where that credit goes. They can also control the price of debt by forcing banks to lend at a certain rate and subsidising the rest. Hence, the role of central banks will be reduced, and the role of government will increase.

    In Italy, about 40% of the loans made by the Italian banking system are guaranteed by the government. The Italian Energy company Enel was given a Euro 16 bn loan by the banks, all underwritten by the government, and that was a large amount of money creation. This was an Individual Government bypassing the Unity Money System of Europe. A lot of other European Countries are also doing this - especially Germany - and no one is paying attention. Europe has come up with an Industrial Policy to create a supply chain alternative to China, and it has asked the banks to fund it. This cannot keep happening, especially when there is supposed to be a single unified system in the Euro Zone. Something will give.

    In the UK, they have told banks not to foreclose on energy companies that are in trouble. There are a lot of subsidies on energy. This is a form of Financial Repression.

    When there are 2 great powers, there is conflict - it may not always be physical conflict, but it can be financial conflict, like between the US and China. There is a drive to reduce dependence on China's supply chain. Private credit is unlikely to start flowing back to China. Yuan is not likely to be a reserve currency. Only Russia is holding Chinese bonds. Saudi Arabia is starting to take the Yuan in exchange for oil, but it is selling the same again. In 2007, China's debt to GDP-ratio was roughly half of the US, and now it is virtually the same at about 300% of GDP and has the same problems as the US.

    All those holding Russian Government Bonds overnight became worthless as they had no Dollar value. Another form of Financial Repression was when the US seized Russian reserves. That was expected—what was surprising is that Europe, Switzerland, and even Singapore seized Russian reserves. It did not undermine the dollar and, in fact, strengthened it. Further, it made gold more important. Gold can be held in your country and is money without credit.

    Emerging Market's total debt to GDP is mostly less than 200%, as they learned from the Asian Crisis. India has grown its GDP, too, in this period, but our total debt to GDP is roughly 170%.

    Financial repression will go on for about a decade or more until the Total Debt to GDP is more manageable - to below 200% from over 300% debt to GDP

Investment

INVESTMENT IDEAS IN THIS DECADE OF FINANCIAL REPRESSION


  • Gold as a monetary asset and silver as a quasi-monetary asset are always an investment option.
  • Equities can do well in this period, but not all equity. Value is of paramount importance, and volatility is going to be a part of the journey :
    • The S&P 500 is very expensive because the Price / Earning is at 23 times and 4.1 times book value and 4.6 times book value for the Nasdaq - it is in bubble territory, so the US is not really an equity option.
    • However, equity of the rest of the world in dollar terms were in March 2020 lower than they were in 2000. So they have gone nowhere for 20 years. Today they are just about24% higher since that date and hence there is still value here.
    • With Financial Repression, Governments are going to concentrate on Infrastructure, Energy and Defence. So, opportunities to invest will be there. Mitsubishi Heavy Industries is up 150% this year. UK shipbuilding is experiencing a resurgence. Reliance is building a factory on 5000 acres in Jamnagar, among others, to manufacture Photovoltaic Panels. On the other hand, the windfall tax on high oil prices for corporations in India is also a form of financial repression.
    • However, the biggest opportunity would be to reduce China's dependence on the supply chain, which is happening all around the world. In India, the Atmanirbhar Bharat scheme is another form of Financial Repression to guide investment and credit to that end, and hence, there is an opportunity to invest in Manufacturing companies
    • Inflation is likely to be sticky, and there are some companies which have pricing power and will benefit from inflation, regulated moderated interest rates and hence increasing margins
    • Index investment and ETFs may not be the place to invest as the Index weightage is based on companies that have already performed. Algo-trades have to be careful as liquidity may not be there.
  • Bitcoin - will be like a baseball card, not a store of value, according to Russel Napier. However, a Stable coin that is linked to the currency of a country and issued by a company could have some value.
  • Central Bank Digital Currency is the biggest threat to liberty and a form of Financial Repression. As they can completely control the movement of credit through the system, that would be totally in the whims and fancies of some people at the Central Banks. However Governments are likely to go slow with this development so see the consequences of this unknown new area.

Hence, in conclusion, there was a time when it was believed that only expanding the Central Bank's balance sheet could avert a crisis, but now it is possible to expand commercial banks' balance sheets, with a government guarantee to create credit. The role of Central Banks will be reduced, and the government will direct the cost of capital and the end use of capital. Inflation would probably be maintained at around 4% (as the 2% Fed target is unsustainable, and 6% would cause real hardship). This has already started and will only gain momentum over the next decade until GDP grows and the total debt to GDP falls below 200%.

Investment

EQUITY MARKET


The trend is still intact. However, a weaker BJP Government would keep markets suppressed. It looks unlikely that there would be a change of government, but if it does happen, there would be a violent movement like that which happened in 2004 (although recovery was fast). However, over long periods of time, it is corporate profits which move the equity markets as the event effect is temporary.
DEBT MARKET

DEBT MARKET


This month, the RBI planned to buy back about 1 lakh cr of government bonds. Liquidity is tight during the election period because the government slows down spending due to the Code of Conduct. With the government buying back bonds, liquidity is infused into the economy. However, only a little over Rs 12,000 cr was actually bought because the bond prices rose, the yield fell, and they did not want to signal any falling interest rates. However, at the right price, they will continue to buy bonds.

RBI has given the government an all-time high dividend of Rs 2.11 lakh crores. This has caused the yields to fall, as the government would need to borrow less with this dividend. However, the record dividend is an indication that the Central Bank's balance sheet is in a healthy position.

GOLD & SILVER MARKETS

GOLD & SILVER MARKETS


Gold and silver went on a massive run-up at the beginning of the month. However, both gold and silver became volatile after that. Gold ended the month just over 0.5% up, but silver did very well and went up over 13% in the month. It is understood that the reason for this is that India is buying massive quantities for industrial use and due to the retail purchases made by the Chinese.