We summarise below the Q&A section of our recent webcast with Russell Napier. The listener submitted live Q&A that ranged over a wide variety of market and investing topics. We think it is particularly pertinent to consider Russell’s views on the changing landscape for inflation. Previously an ardent deflationist, Russell now thinks an inflation is likely.
What period in financial history does the current economic situation remind you of?
The best playbook probably comes from 1966-1982. Inflation was over 200% for the period. Equities were highly priced going into the period, and it is a good reminder that “price is what you pay, but value is what you get.” Interest rates went higher, but profit margins did not keep pace. Gold outperformed and did significantly better than gold shares, and surprisingly oil failed to make a real return. Few sectors in the equity market generated a real return. Systems without debt problems didn’t have a need to pursue financial repression to inflate away World War II debts (e.g Switzerland, Hong Kong).
Why do you think people in finance do not pay more attention to financial history?
To quote Charlie Munger: “Show me the incentive, and I will show you the outcomes.” People in finance are compensated on a very short term basis, and this conflicts with the longer term goals of their investors. The traditional partnership model of a firm like Cerno Capital should allow it to think on a more long term basis, and align with its investors best interests.
What do you think will happen to Hong Kong given China’s changing attitude towards to the City?
In the past, Hong Kong has been a wonderful bridge between East and West for goods, capital and skills. That period is over. We are entering a new Cold War, which necessarily means China will have less relationships with the rest of the world. Whether the conflict is US or China made is irrelevant, the fate of the city is sealed. Regional hegemons will circle their respective wagons closer during a cold war and Hong Kong falls in China’s sphere of influence.
What are the risks to the US Treasury markets given the split between the US and China?
The dollar is likely to remain the World’s reserve currency for many years to come. As battle lines are drawn, countries will increasingly have to choose between the US and China. Most will choose the US. Most of the World’s reserves are held by a few countries, and South Korea and Japan will undoubtedly choose America.
What are the triggers for the inflection point from deflation to inflation?
In my opinion, we are on the cusp of a sea change. Whilst Central Banks play a role in money creation, the real key to an increase in the supply of money sits with the banks. The fractional banking system means banks are able to literally ‘create’ money out of thin air. With banks being coerced to lend through the pandemic, with implicit state guarantees, money supply growth is picking up. I expect the velocity of money will pick up sharply too after lockdowns are eased. Inflation could be running as high as 4% YoY by this time next year. If that is the case, I would recommend investors consider owning gold, asset-heavy equities and mass residential real estate. I say mass residential because luxury is overpriced and plutocrats will come under pressure. US real estate looks good on that basis. Governments will ensure rates stay lower than would otherwise be appropriate.
Is the rally off the lows in the markets justified here?
The stock market is soaking up the extra liquidity injected into the system during this crisis by the Federal Reserve. As activity picks up, I expect this tide to begin to subside. The market will begin to reappraise the existence of inflation in the system. The types of asset allocation an investor makes must adjust accordingly.
What is your view on cryptocurrencies or the potential for a Central Bank backed cryptocurrency?
Any Central Bank would be disinclined to fully commit to a cryptocurrency, as the point of a crypto is that it is limited in supply. The ability to print money is a critical pillar for any modern Central Bank, so they would simply not sign up for it. Cryptocurrency is more like baseball card trading. It may have a value, but it’s unclear what underpins it.
Is there any hope for an inflation induced recovery when we have demographic headwinds?
Governments have now taken control of commercial bank balance sheets and loan books. They can directly engineer higher growth, and inflation is inevitable. They will allocate money badly, but they are not using their balance sheet. These are contingent liabilities. There will be a green investment stimulus, an inequality stimulus, a reconstruction package. This will look like capitalism with Chinese characteristics. This will crowd out private investment returns, and may end up in a repeat of 1970s.
Could you give some historical context on the decline and resurrection of this stock market?
This was a recession governments chose to embrace. The rebound has been the second biggest in history. These are extreme moves relative to any period in history. The pace of the response was more rapid too. What is really going on is a revolution in the creation of money that will impact us for the next thirty years. This is a fundamental shift in the world of money and investment. People may be overconfident about the powers of the authorities to control and manage stock market outcomes.
If you would like to view the recording of the full webinar with Russell, please click here.