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We need to prepare for an era of increasing financial repression and persistently high inflation. That's according to market analyst and historian Russell Napier in a interview with The Market. Governments will become more involved in the allocation of capital in order to prevent debt deflation and stimulate economic growth. By supporting credit and thereby boosting inflation, governments can reduce their debt burden. What can we expect in the coming years and how can savers protect themselves against this?
Since the credit crisis of 2008, our financial system has become fundamentally unstable, according to Napier. Public and private debts are far too high, which means that central banks and governments have to intervene in every crisis to keep the economy afloat. To bring debt back to sustainable levels, we could repay more or cancel debts, but neither of these are popular solutions. The path of least resistance is for governments to boost economic growth and thus reduce debt in relation to gross domestic product. According to Napier, this also happened after World War II, when countries rebuilt their economies and debt-to-GDP declined.
In order to be able to carry out this process successfully, it is important that the lending remains at the same level. Under normal market conditions, this is an interaction between banks and the free market. If there is more demand for credit, banks can provide it. If there is little risk, banks provide plenty of credit. However, if the future becomes uncertain, many banks will turn off the credit tap. However, if banks throttle lending too much, a recession can turn into a depression. Governments try to prevent this scenario, for example by guaranteeing loans. It is the cheapest way for governments to support the economy. Companies can borrow more easily and cheaply with a guarantee from the government and if things go well, it does not have to cost the government money. Germany, for example, has already set up a new guarantee scheme for loans.
Governments will increasingly determine which sectors receive these types of credit guarantees and thus steer bank lending. This also happens indirectly with so-called ESG investing (Environment, Social and Governance), which assesses investments on the environment, climate and sustainability. We are already seeing that pension funds and investment funds are preferring investments that meet these standards under social pressure, at the expense of investments in companies that are involved in fossil energy sources. In this way, too, capital is directed towards certain sectors. These forms of financial repression will only increase in the next ten to twenty years, Napier expects.
The prospect of persistently high inflation to inflate away debt is, of course, very unfavorable for savings and government bonds. Interest income will lag far behind inflation in the coming years, which means that savers will lose purchasing power in favor of debtors. To prevent investors from exiting government bonds, the government will have to apply more financial repression. According to Napier, pension funds and insurers will therefore be forced to buy more government bonds in the coming years to ensure that the financing of the national debt does not become a problem.
In recent weeks we have been in the United Kingdom dear that governments cannot spend money indefinitely. If the market loses confidence in the sustainability of the sovereign debt, this translates into higher bond yields and a depreciation of the currency. This market mechanism can be eliminated by central banks, which can buy government bonds to calm the market. Since 2008, central banks have been buying government bonds on a large scale to keep interest rates low.
According to Napier, this dynamic will change in the coming years, as governments and central banks are now diametrically opposed. Central banks are tightening policies to bring down skyrocketing inflation, while governments want to spend more money to support the economy. In doing so, they are actually fuelling inflation further. According to Napier, governments will ultimately prevail in this area of tension. The social pressure to support the economy will become so great that central banks will eventually succumb to the pressure to keep the system afloat.
According to Napier, central banks don't have much power today. The control of money creation is no longer in the hands of central banks, but in the hands of governments. Governments already played a major role during the corona crisis and are now doing so again with the current energy crisis. An increasing proportion of all new business loans are covered by government guarantees. Governments will take over the risk from banks, allowing banks to continue lending to keep the economy going. The CEO of Commerzbank has already said in July that the German government will not let large companies go bankrupt.
Napier foresees a new 1970s scenario with stagflation and high unemployment. This is not yet the case, because unemployment is still very low. According to the market analyst, stagflation will only occur after years of misallocation of capital. He expects a period of economic growth in the coming years through new (government) investments, which will be followed by a period of high inflation and the negative effects of years of misallocation of capital. Only then will people be open to stricter fiscal and monetary policies, such as Volcker's interest rate hikes and Tatcher's conservative fiscal policies.
According to Napier, savers and investors should not hold government bonds in the coming years, because they will lose value. There are still opportunities in the stock market, especially in sectors such as energy, alternative energy sources and defence. He also sees buying gold as a good alternative, because the precious metal will become more popular in a world with long-term high inflation. The fact that the Gold price According to him, this year is under pressure mainly due to the strong dollar, because in other currencies the precious metal is doing quite well this year.
According to Napier, investors should invest in companies that are located in the same area. This is because of the risk of financial repression. Think of investments in China and Russia that you may not get back in the event of rising geopolitical tensions and new economic sanctions. Contrary to popular opinion, Napier expects Western economies to industrialize further, because Europe and the United States want to become less dependent on other countries for vital industries and therefore have to develop this industry themselves. Investors can also anticipate this in their investment strategy.
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