Russell Napier, a global macro strategist and the Co-Founder of ERIC, tells Financial Sense Newshour that Turkey is a likely candidate for triggering capital outflows from emerging markets and, with global debt burdens at these levels, zero percent interest rates and physical currency are considered too restrictive for policy makers.
Financial Sense: A further strengthening of the dollar and the potential problems this could cause for emerging markets has become a big topic, something you’ve been talking about for quite awhile now. If we start to see problems arise, what sort of measures do you think will be taken?
Russell Napier: It is not new for the Fed to ride to the rescue of emerging markets. We saw actions in those regards in 1982, 1994, 1998, and I would argue 2008 partially as well but that action was always the same and it was reducing interest rates, [which] … is just not going to be possible for the Federal Reserve from here. What can the Fed do to bring down the dollar if it can't reduce interest rates? Well, there are some more dramatic things it can do. It can open significant swap lines; Mr. Bernanke in his famous helicopter speech actually mentions doing QE over somebody else's assets denominated in other currencies, but the history of these things shows that to get a mandate to do these extreme measures you need things to go very wrong first and I suspect that it would be some sort of emerging market crisis … Believe me there is something even more aggressive than quantitative easing but to get that level I think we'll need a crisis first.
FS: Before we get to some of these more extreme measures, you’ve argued that capital flight out of the emerging markets is a greater concern today than in the past. Why is that?
RN: The reason it's more of an issue today is that the debt capital provided to emerging markets historically came from banks and they may have been capable of distinguishing one country from another and saying, “Just because Turkey has problems I won't pull my capital from the Philippines,” but today a significant portion of EM debt capital is provided by bond investors. And quite a proportion of that is provided by pension funds, but sadly a very, very large proportion is also provided by open-ended funds which can get redemptions.
FS: You mentioned Turkey. Is this a specific area of concern?
RN: We’re looking at Turkey as flashing a short-term danger signal … Just to put it in context: the amount of money borrowed by Turkey is similar to the amount of money that was borrowed by Bear Stearns—it's about $400 billion. Bear Stearns of course had off-sheet liabilities as well, but on-sheet liabilities of $400 billion. Lehman Brothers was $600 billion, so that puts it in context. This is a big number and it's lent from outside the system so it does have issues for financial stability, particularly in Europe and we need to make that clear… [Also], geopolitically it's one of the most important places in the world given what's happening on its borders and it’s a member of NATO. So there'll definitely be a response.
FS: One of the extreme policy responses you recently wrote about is banning the use of cash, which well-known Harvard economist Kenneth Rogoff wrote about last year (see here) and presented at the NBER Macroeconomics Conference. What was the argument he made in that paper and how does that fit into some of the issues we’ve discussed?
RN: Kenneth Rogoff wrote that paper because everyone understands the arbitrage limits to negative nominal rates. But he pointed out that there could be reasons why central banks would want to have negative nominal rates of 50, 75, 100, or 150 basis points; and as long as cash exists then that probably is impossible because people would move out of deposits or bonds into cash and get a massive yield pickup. So you might want to make cash illegal—just ban the use of cash and make it only electronic. And if it's only electronic it has to stay within the system and if stays within the system, then if central banks wanted to have negative nominal rates of 5% percent—500 basis points—and there's no cash to run into then that's exactly what central banks could achieve … I don't think that's going to happen. I don't think that central bankers are going to ban cash but it is getting much more difficult to get a hold of cash … it remains a theoretical paper and to get to those extreme levels I think things would have to get very, very much worse than where things are today.
FS: How is this similar to banning the use or possession of gold in the 1930s?
RN: We live in an extreme world where even paper is too hard a standard. And what is that extreme world? Well, that's pretty easy—it's a world of excessive debt. The world has never seen debt levels like this before and that's when you combine the private and the public. After wars of course public debt levels are very high but usually private debt levels are very low and when we aggregate our debt levels today we've just never seen anything like it. That's why you'd need particularly soft money and that's why they're even contemplating banning cash because that arbitrage would keep interest rates pretty close to zero. And what they're saying is at this level of debt in the global system, even zero interest rates are still too high.