The investor who anticipated the return of inflation now sees a paradigm shift in the economy

After years (decades) of price stability and little change in prevailing trends in the economy and markets, everything seems to be changing in a very short space of time. Russell Napier, co-founder of the financial research firm Eric and an honorary professor at the University of Stirling, predicted this dramatic turn of events in the summer of 2020 (much of the world was still struggling with deflation) through his regular newsletter ‘The Solid Ground’. This financial expert is not known for releasing dozens of catastrophic forecasts every year, rather he is known in the investment world for his caution. But now, Napier believes that the change taking place globally is visible and evident,the developed world is shifting towards a new order in which the government has greater control over the economy and even the creation of money. This change will have consequences.

In an interview granted to the Swiss medium the market , Napier makes a general review of the situation in which advanced economies and markets find themselves. These countries are facing a paradigm shift that is taking place little by little and without the majority of the population realizing it.

In the last four decades the western world has had the idea that economies were guided by free markets. Now, “we are in a system in which a large part of the allocation of resources is no longer left in the hands of the markets. Of course, I am not talking about a command economy or Marxism, but an economy where the government plays an important role in capital allocation,” he says.

Why does this happen? Governments need to control money and the economy to stay afloat with historically high debt. “The main reason is that our debt levels have simply grown too high. Total public and private sector debt in the US is 290% of GDP. It’s a whopping 371% in France and over 250% in many other countries. Western economies, including Japan. The Great Recession of 2008 already made it clear to us that this level of debt was too high.”

money control

“My structural argument is that the power to control money creation has shifted from central banks to governments. By issuing state guarantees on bank credit during the covid crisis, governments have effectively taken over the levers to control money creation (previously in the hands of private banking and central banking. Of course, the rejection of this prediction is that this was just a temporary emergency measure to combat the effects of the pandemic. But now we have another emergency, with the war in Ukraine and the accompanying energy crisis,” says an expert. One emergency after another, this is what awaits us.

“This means that governments will not back down from these policies. Just to give you some statistics on bank loans to companies within the European Union since February 2020: Of all new loans in Germany, 40% are guaranteed by the government. In France, it’s 70% of all new loans, and in Italy it’s more than 100%, because they’re refinancing old credit that’s due to new government-guaranteed schemes.Recently, Germany has come up with a huge new guarantee scheme to cover the effects of the energy crisis. This is the new normal. For the government, credit guarantees are like the magic tree of money: the closest thing to free money. They don’t have to issue more public debt, they don’t need to increase taxes,they just issue credit guarantees to commercial banks,” says Napier.

Years of financial repression

Regarding the markets, his vision is somewhat dark for the average investor: ” We are entering a stage of structural financial repression that will last for 15 or 20 years.” This means that investors in bonds and shares will lose money in real terms (discounting inflation), unless they manage to position themselves in specific assets that can gain in this type of environment. This is also part of the paradigm shift, a shift that governments need to stay afloat with otherwise unsustainable debt.

“Financial repression means stealing money from savers and the elderly slowly. The slow part is important so that the pain does not become too apparent. We are already seeing respected economists and central bankers arguing that inflation should be allowed at a lower level .” higher than the 2% target they set in the past . Our reference frame is already shifting upwards,” warns this expert.

“The ECB and definitely the Bank of England and the Bank of Japan are there. These countries are already well on their way to financial repression. It will happen in the US as well, but we have some delay there,” he explains. Financial repression is very hard for savers and for a good part of the population, but if you delve into its impact, you can understand why central banks and governments are allowing this situation. The answer is clear, financial repression favors highly indebted governments. Inflation is going to lend a very big hand in reducing the debt to GDP ratio of the European and US economies.

“Financial repression supposes a transfer of wealth from savers to debtors and from the old to the young “, comments this expert.

On the other hand, financial repression also supposes an increase in public income unless deflation measures are adopted. As prices rise, the taxes collected increase in absolute terms and sometimes also in relative terms (as is the case with personal income tax thanks to the brackets). Governments are managing to hog a lot of power, not only through increased chronic public spending, but also through control of the money itself. The latter is a paradigm shift, from the free market to directism or statism, says Napier.

In this environment, investing becomes extremely complicated. Beating inflation has been easy for years, but now it’s nearly impossible. Napier offers some advice: “First of all: avoid government bonds. Government bond investors will be robbed slowly. Within equities, there are sectors that will do very well. The big problems we have (energy, foreign exchange climate, defense, inequality, our dependence on China production) will be resolved with massive investments. This capital spending boom could last a long time. Companies geared toward this capital spending renaissance will do well. Gold will do well once people realize that inflation will not go down to pre-2020 levels, but will be somewhere between 4-6%.”

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