“When the facts change, I change my mind - what do you do, sir?”
― John Maynard Keynes
For the past 40 years, largely due to the forces of globalization and cheaply imported goods, the world has experienced a prolonged period of subdued inflation. However, 2020 marks a significant shift in the inflationary outlook and noted deflationist Russell Napier is now warning investors to prepare for rising inflationary pressures ahead.
Here's what he had to say in a recent interview with FS Insider (see There's a Major Inflationary Trend Brewing and We're in the Early Stages, Says Russell Napier for audio).
Money Creation Takeover
Napier, who is well-known for his deflationary views in prior decades, switched his outlook this year. A key reason for this change, he stated, is that the mechanism for money creation has changed.
In essence, commercial banks are the main entities that drive the money creation process, particularly through fractional reserve banking. They accomplish this when they make loans to individuals, businesses, and even governments. Now, Napier notes, the money creation process has been fundamentally altered through the widespread use of credit guarantee programs.
“It’s created a monetary revolution... It is this mechanism change that almost certainly ensures we will see much higher inflation going forward.”
Because the government has been providing credit guarantees to banks, the government guarantees the principle behind that loan. This means commercial banks are able to make loans they would never make in the past, due to excessive credit risks.
“In the normal course of things, bankers do not lend money to people they know aren't going to pay them back,” Napier said. “But in this occasion...if the loans go bad, there will be a transfer from the government into the banks to compensate for that loss.”
Inflation Baked In
We now see the highest rates of broad money growth we've ever seen, while inflation is currently running close to 1.2 percent. Broad rates of money growth in OECD countries is running it at 18.2 percent year-on-year. There has only been a very brief period in 1987 when the total growth in global money has been higher than it is today, Napier noted. At that time, global inflation was 11 percent.
It is also important to remember that this money is already in existence. It’s just a matter of it making its way into the system. When the velocity of money normalizes, Napier stated, we should see much higher rates of inflation automatically.
We should expect to see this money be utilized, he noted, because of who the money has been lent to. Because these loans are targeted to small businesses, essentially to keep them afloat, it is very likely that most of it will be spent.
For small business owners, the only way for them to keep afloat in tough economic conditions is to spend money. They can’t hoard it or use it to buy back equity, as larger corporations have done.
“It's not just the change in the mechanism of money creation,” Napier said. “It's not just that growth rates have at least doubled in some countries and tripled in other countries, in terms of the growth rate of broad money. It’s who the money has been given to. These are people and small businesses who are highly likely to use this money for transactions and consumption.”
Implications for Savers
In an environment where inflation is favored, a debt forgiveness on a federal level may become a reality, those with high debt loads are winners, and savers lose out. Beyond supporting distressed small businesses, Napier sees real estate benefiting from the shift to inflation.
A combination of higher wage growth coupled with policies that deliberately hold down interest rates should be good for the price of residential property, Napier noted. As property prices increase and debt is inflated away, this may be a viable place to protect wealth.
Equities should also benefit, which we’ve seen already. Napier does not believe this trend is over either and says that we are still in the early stages of this reflation.
This should continue until central banks have to cap long-term interest rates, which is likely a way off. Gold has also historically benefited when inflation is set permanently above interest rates, Napier stated.
“I think this will continue for at least a decade, and probably more than that,” he said. “Of course, there will different types of equities that benefit from higher inflation. … What you really need is cost control. So if you have a good equity manager who can spot those companies, then the ability of those stocks to protect you from inflation could last for many years and well beyond the period when we bring in a cap on the yield curve.”
To listen to our full-length interview with Russell Napier, click here. If you're not already a subscriber to our FS Insider podcast where interview book authors, strategists and industry experts from across the globe 3 days/week on all things economics, finance and markets...
Written by Ethan D. Mizer