From time to time, we read an article which provides a profound insight – perhaps some new information we didn’t have previously, a new way of looking at things, or an excellent summary of an ongoing debate in the financial world.
When we read a recent interview with Russell Napier – on inflation and why it’s here to stay – in the Swiss publication The Market, we knew instantly that it ticked all three boxes.
For those who may not know him, Russell Napier is a financial historian and investor. He has written several books, such as Anatomy of the Bear and The Asian Financial Crisis, and publishes The Solid Ground newsletter, which deals with global macroeconomic strategy for clients. He was one of the first commentators to warn about the risks of high inflation – over two years ago.
The crux of the interview is that he believes inflation is here to stay – in the language of markets, high inflation is structural, not transitory. The reason he believes this is that debt levels (both government and corporate) are simply too high. There are two ways to reduce high debt levels: (i) pay down the debt; or (ii) debase your currency. Currency debasement (inflation) leads to higher revenues for companies and governments, making debt easier to service as the value of it is fixed. Paying down the debt is a painful process, so governments (unwittingly) are likely to choose the path of least resistance and highest votes – inflation.
How is the government stoking inflation? Through high levels of spending (e.g., pandemic unemployment payments, energy bill subsidies) and, in Europe at least, government guarantees of debt. The interesting thing is that central banks are leaning against this by raising interest rates – so, on one hand, you have inflationary fiscal policy, while on the other hand you have contractionary monetary policy. Where will this tension end? It seems unlikely that central banks will, in Napier’s view, go to war with governments, so that the end result will be moderate-to-high inflation for a number of years. This will erode the value of debt (in effect, deleveraging), and the end result may be stagflation as government-directed capital allocation is often economically inefficient – resulting in a situation where the economy doesn’t grow but inflation remains high. The results will likely be popular for a while (in particular wage growth) but the end result of stagflation will not be.
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