Are advanced economies repeating 1939-1979?

[Markola]

This compelling, I think, macro economic thesis puts the recent tension between governments and central banks and their reactions to challenges in a convincing context. Covid and the Ukraine War have caused governments to seize the reins from markets and central banks, repeating the cycle of 1939 - 1979, with fairly predictable costs and benefits and winners (banks, naturally, manufacturing, government and corporate debt loads) and losers (savers, especially govt bond holders.):

“In summer of 2020, you predicted that inflation was coming back and that we were looking at a prolonged period of financial repression. We currently experience 8+% inflation in Europe and the US. What’s your assessment today?”

“My forecast is unchanged: This is structural in nature, not cyclical. We are experiencing a fundamental shift in the inner workings of most Western economies. In the past four decades, we have become used to the idea that our economies are guided by free markets. But we are in the process of moving to a system where a large part of the allocation of resources is not left to markets anymore. Mind you, I’m not talking about a command economy or about Marxism, but about an economy where the government plays a significant role in the allocation of capital. The French would call this system «dirigiste». This is nothing new, as it was the system that prevailed from 1939 to 1979. We have just forgotten how it works, because most economists are trained in free market economics, not in history.”

https://themarket.ch/interview/russell-napier-the-world-will-experience-a-capex-boom-ld.7606

 

[Sunset]

I'm just worried we are going to repeat the mistake of WWI, and let some minor issue create a world war killing millions to billions of others.
WWI was caused (or triggered) by a young man who killed some heir to the Austro-Hungarian Empire in 1914, as he drove by in his car.
WWI was triggered by the death of 1 person and lead to the deaths of 15 to 22 million and many more injured, and massive destruction of property.

This time, the death toll will be Billions as soon as nukes get involved.

 

[marko]

Well, "...an economy where the government plays a significant role in the allocation of capital" is troubling, but throw in ESG considerations and a move away from metritocracies and suddenly all bets are off.

 

[OldShooter]

There is a missing interview question: "You say you have been in the investment advisory business for 30 years. What is the historical track record for your predictions over that period? In other words, what evidence is there that your forecast here has credibility?"

 

[MichaelB]

Thanks for the link. Napier is a smart guy and this is a good interview.

One concern I have is with his investment advice.

Within equities, there are sectors that will do very well. The great problems we have – energy, climate change, defence, inequality, our dependence on production from China – will all be solved by massive investment. This capex boom could last for a long time. Companies that are geared to this renaissance of capital spending will do well

Companies and industry sectors that invest large amounts of extended periods are not highly profitable. The investment may lead to greater future profits, but while they are investing their profits and cash generation tend to fall.

One reason energy companies are so valuable today is the huge amounts of cash they generate, and return to shareholders. If that cash all goes to investment, profits will fall and market valuations may suffer.

 

[Closet_Gamer]

One reason energy companies are so valuable today is the huge amounts of cash they generate, and return to shareholders. If that cash all goes to investment, profits will fall and market valuations may suffer.

That pre-supposes that the capital being deployed doesn't generate returns as least as strong as the existing business that was kicking off the cash.

 

[MichaelB]

That pre-supposes that the capital being deployed doesn't generate returns as least as strong as the existing business that was kicking off the cash.

Yes, it does. That is the norm, however, in the industries he mentions as examples.

 

[6miths]

Sorry didn't read the article but isn't it hard to argue that what has happened since 2008 has been 'free-market' driven. Seems we have arrived at this point riding the crest (for the rich) of largely unprecedented government intervention.

 

[Markola]

I thought the central points were fascinating. Central banks are constrained by the vast debt loads countries and corporations bear. For example, if they raise interest rates too far, countries and corporations have trouble servicing their gargantuan debts. The Fed is maybe the only central bank that isn’t already neutered, and even the Fed has limits. We’ll never see Volker level interest rates.

Allowing 4-6% inflation to rip for the next few decades will allow governments to quietly reduce their debt loads. We savers will quietly pay for it as our spending power is reduced 4-6% per year. Compounded, every dollar a saver has will be worth 50-70% less in just ten years. That’s a backdoor way to tax the public, reduce the debt and bypass politicians who won’t raise taxes. There is no free lunch, though, and retirees’ lunches will be among those eaten. The ultimate result in a few decades will again be stagflation, which we do not have now, because unemployment is so low.

Covid and Russia’s war have reminded governments that they have a way to not only reduce the debt but to carry out their programs: They simply choose which gargantuan debts to guarantee and which not to. Pandemic? Backstop healthcare-related debt. Climate? Backstop renewable energy debt. War? Backstop defense companies. Etc.

It’s clever government through directing private capital allocation, though they will never talk about it. To keep this string civil and in-bounds, I see no reason to think it won’t be entirely bipartisan, so we don’t need to go there.

 

[aja8888]

I thought the central points were fascinating. Central banks are constrained by the vast debt loads countries and corporations bear. For example, if they raise interest rates too far, countries and corporations have trouble servicing their gargantuan debts. The Fed is maybe the only central bank that isn’t already neutered, and even the Fed has limits. We’ll never see Volker level interest rates.

Allowing 4-6% inflation to rip for the next few decades will allow governments to quietly reduce their debt loads. We savers will quietly pay for it as our spending power is reduced 4-6% per year. Compounded, every dollar a saver has will be worth 50-70% less in just ten years. That’s a backdoor way to tax the public, reduce the debt and bypass politicians who won’t raise taxes. There is no free lunch, though, and retirees’ lunches will be among those eaten. The ultimate result in a few decades will again be stagflation, which we do not have now, because unemployment is so low.

Covid and Russia’s war have reminded governments that they have a way to not only reduce the debt but to carry out their programs: They simply choose which gargantuan debts to guarantee and which not to. Pandemic? Backstop healthcare-related debt. Climate? Backstop renewable energy debt. War? Backstop defense companies. Etc.

It’s clever government through directing private capital allocation, though they will never talk about it. To keep this string civil and in-bounds, I see no reason to think it won’t be entirely bipartisan, so we don’t need to go there.

Eventually, you will own nothing and be happy!

 

[marko]

I thought the central points were fascinating. Central banks are constrained by the vast debt loads countries and corporations bear. For example, if they raise interest rates too far, countries and corporations have trouble servicing their gargantuan debts. The Fed is maybe the only central bank that isn’t already neutered, and even the Fed has limits. We’ll never see Volker level interest rates.

Allowing 4-6% inflation to rip for the next few decades will allow governments to quietly reduce their debt loads. We savers will quietly pay for it as our spending power is reduced 4-6% per year. Compounded, every dollar a saver has will be worth 50-70% less in just ten years. That’s a backdoor way to tax the public, reduce the debt and bypass politicians who won’t raise taxes. There is no free lunch, though, and retirees’ lunches will be among those eaten. The ultimate result in a few decades will again be stagflation, which we do not have now, because unemployment is so low.

Covid and Russia’s war have reminded governments that they have a way to not only reduce the debt but to carry out their programs: They simply choose which gargantuan debts to guarantee and which not to. Pandemic? Backstop healthcare-related debt. Climate? Backstop renewable energy debt. War? Backstop defense companies. Etc.

It’s clever government through directing private capital allocation, though they will never talk about it. To keep this string civil and in-bounds, I see no reason to think it won’t be entirely bipartisan, so we don’t need to go there.

Nice analysis! Of course, should the Fed get us down to 2.5-3% in the next 12-18 months your argument becomes less valid so, respectfully, I'm hoping your not correct...

 

[Markola]

Thank you. I hope it’s wrong, too, and the author allows for additional factors to mitigate a capex surge leading to eventual stagflation. I was trying to filter the author’s hypothesis, which was novel for me.

 

[NW-Bound]

Interesting analysis and prognosis.

The time frame that Russell Napier talks about, I will be too old and senile at the end, if still alive, to know what is happening. And the end is a stagflation like 1980, which I remember well.

Well, I guess I can go on enjoying my life, because it will not happen for a few years.

 

[Markola]

^^^Yes, of course we all want to know what 4-6% long term inflation and resulting 50-70% (ballpark) dollar debasement each decade (!) would mean for us. I’m 56 and it does not sound good. But as always, my strategy is to buy and hold some of everything, expecting that some will zig while others zag long term. At last count, our portfolio exposes us to some 28,000 securities worldwide:

Domestic stock index funds, assuming some sectors will thrive in unpredictable cycles. See tech’s late nosedive and energy’s surge.

International stock index funds, which reflects some different sectors and ought to do better as the dollar eventually weakens .

Domestic Bond index funds, assuming that they will eventually contain mostly higher yielding issues, but with a lag. (We can and do argue funds vs. individual bonds on other threads, so no need to repeat it here.)

International Bond index funds. They seem to track domestic ones almost exactly but there’s diversification value. I’m trusting Vanguard on this one.

My house with 3.6% mortgage. We’re fortunate to live in a leafy college town that’s also the state capital and Zillow says this house has appreciated around 4.25% long term and, lately, a lot more than that/year. Someday we could use the equity somehow TBD.

Bitcoin, which is the only investable asset whose supply is unaffected by its demand, making it resistant to global monetary debasement. (I can’t say more on this topic here or else I’ll be thrown in the pokey.)

I still have a toe hold in the work world as a consultant and can jack up my prices.

Wait to take SS when we are both 70, which is the best inflation and politician-resistant annuity out there.

Anyway, that’s how I try to face up to the world and what seems to be the inflationary pivot it has undergone. I’m just not one who thinks 2% is coming back. Given money printing since 2008, I think it was always higher than 2% but Americans were able to ship the excess dollar supply overseas, mostly to China, which isn’t buying dollars now, so how much longer?

How do your strategies differ? Maybe I’ve missed something, like TIPS.

 

[marko]

I re-read the article. His main premise is that "this time is different" due mostly to gov'ts controlling more of the money creation rather than the banks.

He could be right, but for now, I just see inflation as a manifestation of Covid, supply issues, Ukraine and hyper-spending on the part of governments to try to get out from under the Covid setbacks and address/correct social ills.

In short, all/mostly short term interventions and excursions from the 'normal' economy.

But what do I know.

 

[Sunset]

I have bought my first TIP, after reading the article above, it seems to me TIPs would be good to hold more of.
The one I bought was 5 yr paying 1.8x% (so if inflation is 3% or higher it seems the TIP will turn out nicely).
I also loaded up on I-bonds via the gift route, so have about $60K worth.

If I got paranoid, all these TIP and I-bond things could be manipulated by the gov't simply refusing to recognize inflation.

 

[Markola]

marko, I actually don’t think he’s saying “this time is different”, rather that governments are using old tools to launch a recurring cycle:

“Engineering a higher nominal GDP growth through a higher structural level of inflation is a proven way to get rid of high levels of debt. That’s exactly how many countries, including the US and the UK, got rid of their debt after World War II. Of course nobody will ever say this officially, and most politicians are probably not even aware of this, but pushing nominal growth through a higher dose of inflation is the desired outcome here. Don’t forget that in many Western economies, total debt to GDP is considerably higher today than it was even after World War II.”

 

[marko]

marko, I actually don’t think he’s saying “this time is different”, rather that governments are using old tools to launch a recurring cycle:

“Engineering a higher nominal GDP growth through a higher structural level of inflation is a proven way to get rid of high levels of debt. That’s exactly how many countries, including the US and the UK, got rid of their debt after World War II. Of course nobody will ever say this officially, and most politicians are probably not even aware of this, but pushing nominal growth through a higher dose of inflation is the desired outcome here. Don’t forget that in many Western economies, total debt to GDP is considerably higher today than it was even after World War II.”

OK. I'm obviously out of my depth here so I'm going to just keep reading the posts. But it's the first time today that I don't know what I'm talking about! So I got that going for me.

 

[NW-Bound]

^^^Yes, of course we all want to know what 4-6% long term inflation and resulting 50-70% (ballpark) dollar debasement each decade (!) would mean for us. I’m 56 and it does not sound good. But as always, my strategy is to buy and hold some of everything, expecting that some will zig while others zag long term. At last count, our portfolio exposes us to some 28,000 securities worldwide:

Domestic stock index funds, assuming some sectors will thrive in unpredictable cycles. See tech’s late nosedive and energy’s surge.

International stock index funds, which reflects some different sectors and ought to do better as the dollar eventually weakens .

Domestic Bond index funds, assuming that they will eventually contain mostly higher yielding issues, but with a lag. (We can and do argue funds vs. individual bonds on other threads, so no need to repeat it here.)

International Bond index funds. They seem to track domestic ones almost exactly but there’s diversification value. I’m trusting Vanguard on this one.

My house with 3.6% mortgage. We’re fortunate to live in a leafy college town that’s also the state capital and Zillow says this house has appreciated around 4.25% long term and, lately, a lot more than that/year. Someday we could use the equity somehow TBD.

Bitcoin, which is the only investable asset whose supply is unaffected by its demand, making it resistant to global monetary debasement. (I can’t say more on this topic here or else I’ll be thrown in the pokey.)

I still have a toe hold in the work world as a consultant and can jack up my prices.

Wait to take SS when we are both 70, which is the best inflation and politician-resistant annuity out there.

Anyway, that’s how I try to face up to the world and what seems to be the inflationary pivot it has undergone. I’m just not one who thinks 2% is coming back. Given money printing since 2008, I think it was always higher than 2% but Americans were able to ship the excess dollar supply overseas, mostly to China, which isn’t buying dollars now, so how much longer?

How do your strategies differ? Maybe I’ve missed something, like TIPS.

I have not made any big change to my investments. Most of my trades are tactical, rather than strategic.

By the time I know what I should have done, usually it's already too late.

 

[MichaelB]

The scenario Napier describes is certainly possible. I’m not sure it is likely, though, there are quite a few assumptions, some are a bit of a stretch.

An investment boom followed by stagflation is unusual, and implies investment capital is poorly allocated. If most of the investment is allocated by gov’t this may happen, but it is still a leap. If capital is generally well allocated, the investment boom will raise productivity and lead to sustainable higher employment and generate the additional GDP needed to pay off the additional debt.

There is a lot of surplus capital now, so the assumption that gov’t will be the ultimate allocator may not happen. The gov’t can impose on the banking sector to finance gov’t debt as Napier assumes, but the shadow banking system is quite large in the US and it cannot be forced to do the same.

Nominal GDP growth rate has been greater than interest rates for some time, so it’s clear that can happen. Both are low, however. Napier bases his analysis on the same happening but at higher rates. I think that is very challenging and am not convinced that the people managing fiscal and monetary policy can make it happen.

This scenario, as described by Napier, is negative for us - people in retirement and close to retirement age. People with fixed pension incomes and low risk portfolios would fall behind. It effectively transfers wealth from older to younger generations. That’s how England resolved its post WW2 debt.

Wage earners in their early to mid years stand to gain the most as the demand for labor is strong and wages will keep pace.

In all it’s an interesting essay.

 

[SecondAttempt]

International stock index funds, which reflects some different sectors and ought to do better as the dollar eventually weakens .

International Bond index funds. They seem to track domestic ones almost exactly but there’s diversification value. I’m trusting Vanguard on this one.

The dollar is so incredibly strong right now that it is hard to see how the situation can continue. A strong dollar hurts US companies that sell overseas. It's clearly driven by high rates here and negative rates elsewhere but that is unsustainable.

I'm not going to speculate in currencies but I am going to buy Euros and yen I expect to need for planned trips while they are cheap. And I will buy foreign stocks. Foreign bonds are trickier since I think the resolution of the current disconnect will involve foreign rates rising and bond prices falling.

 

[tenant13]

While I generally agree with this forecast, I wonder if the level of globalization and the sheer size of the international corporations will be a factor here… Pandemic threw a wrench into that so we’ve been regressing into isolationism and more state driven economies but I don’t think the ties can be dismantled so quickly. At least not quickly enough from some governments’ povs. Maybe in case of a global military conflict… From the human perspective wars are obviously terrible but they serve so many goals for most governments that I feel they’re inevitable. And we are long overdue a big one.