Cover image by Oberholster Venita from Pixabay

All quotes throughout this blog post come from the article “We Will See the Return of Capital Investment on a Massive Scale” by Mark Dittli on themarket.ch published 14-Oct-2022. It’s well worth a read.

—

I read this thought provoking article which was an interview of investment strategist and historian Russell Napier. I was so enthralled by his article that I did something I never do: I watched youtube. Just to glean a little more insight from a brilliant thinker. Russell argues that: “Many investors today still pretend that we’re in the system that we had from 1980 to 2020. We’re not.” And he predicts that we’ve already moved into an investment climate similar to what was in place starting at the beginning of World War II:

“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….This is nothing new, as it was the system that prevailed from 1939 to 1979.”

What he describes is especially applicable to Western economies. In particular those that are heavily indebted (Japan, Southern Europe, USA).

He has solved one of the biggest things I’ve been puzzling about lately. Governments have spent atrocious amounts of money first because of Covid and currently because of Putin and it can’t be possible to keep going on like this. So, what will governments do to get out of all of this debt they’ve accumulated?

Russsell gives an answer: with credit guarantees to commercial banks. Here’s the short of it:

Step 1: A shift in control of the monetary supply. Central banks no longer control the money supply. That’s their job, but they’ve been neutered. Governments (politicians and bureaucrats) effectively control the money supply by guaranteeing loans issued by private commercial banks.

Step 2: Crises happen and the government solves them with money they create using credit guarantees. There’s always a crisis that the public expects the government to pour money into to solve. Covid, Putin, climate change are just the first. There will always be more crises for politicians to solve:

“the politicians in government will say they are elected to pursue these policies. They are elected to keep energy prices down, elected to fight climate change, elected to invest in defence and to reduce inequality”

Governments can’t resist using this powerful tool. So they will use it a lot, and importantly, mostly for their favoured causes.

“For the government, credit guarantees are like the magic money tree: the closest thing to free money. They don’t have to issue more government debt, they don’t need to raise taxes, they just issue credit guarantees to the commercial banks.”

Step 3: Repeat for 15-20 years. This will continue to work for a fairly long time because it will be popular with the public:

“People are screaming for energy relief, they want defence from Putin, they want to do something against climate change. People want that, and elected governments claim to follow the will of the people.”

Step 4: Economies bake in persistently high inflation. Because this tool (guaranteed loans) will get used so much, the economy will face steady, high inflation. But it most likely won’t cause hyperinflation.

We’re already well on our way. The pattern was first proved with covid responses in the West, but already the European energy crisis follows the same four step pattern:

“Out of all the new loans in Germany, 40% are guaranteed by the government. In France, it’s 70% of all new loans, and in Italy it’s over 100%, because they migrate old maturing credit to new, government-guaranteed schemes.”

Nearly all Western governments — and therefore the main trading/saving currencies — are pursuing this strategy (save, perhaps, Switzerland).

Good: Governments inflate away lots of debt - from 300% of GDP down to a more sustainable 200%.

“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”

Bad: Massive capex investments into favoured industries - good for those industries, but on net, not good for the economy because the bets won’t generally be economical. It will take a decade or two for the incompetence to show though.

“When the UK government did this in the 1950s and 60s, they allocated a lot of capital into coal mining, automobile production and the Concorde. It turned out that the UK didn’t have a future in any of those industries, so it was wasted and we ended up with high unemployment.”

Ugly: 6-8% a year inflation, every year for 15-20 years, means any person or company who has wealth is at a high risk of seeing it inflated away. The scenario Russell describes (6-8% for 15-20 years) would mean you lose 58% to 78% of your wealth. That means each $100 you have today will be worth as little as $21.45 in 20 years.

But this government-fueled spending spree can’t go on forever. So it won’t. The result will be stagflating economies in 15-20 years depending on the country / currency / quality of the investments / economy. Stagflation means high inflation plus high unemployment. The high unemployment comes because all of the capex investments will largely be invalidated by then as good investments.

Throughout the article, Russell lays out a few basics. Regarding equities he says:

Within equities, there are sectors that will do very well…This capex boom could last for a long time. Companies that are geared to this renaissance of capital spending will do well.

The article hints at several opportunities and risks for investment in this new investment era. I’ll expand (speculate?!) on Russell’s points.

Russell lays out that some sectors will get massive investment: "The great problems we have – energy, climate change, defence, inequality, our dependence on production from China – will all be solved by massive investment.”

I would add the following additional industries are also likely to do well: research, education, health. All of the industries Russell mentioned and I added are favoured industries by most governments. Why?

• Huge investments already go there. Perhaps because they’ve captured the government. This will only accelerate when more money is up for grabs.

• They’re all social goods. They’re all easily understood by the public and politicians. They’re an easy sell.

Beyond those industries there will be some effects from inflation itself. Those industries that require high long-term capital investments and who aren’t in favoured industries will really struggle. That includes anything Venture Capital (VC) funded, perhaps even tech startups like mine (though I hope we’re favoured!). Capital, both in terms of equity and debt, will be much more expensive over the coming couple of decades.

So that’s broad sectors, but individual companies within sectors will vary dramatically in performance due in this new era too.

The main determining factor of success for a company will be: are you favoured for government largess or not? Some firms will naturally be better positioned than others. All other things being equal, the winners will tend to be:

BIG: Larger firms are more legible to governments and will also be more effective lobbyists. They will get the meetings and be able to organise themselves. Tiny firms, or even collections of small firms won’t be able to organise themselves. Financial firms that are “too big to fail” will indeed not be allowed to fail.

ACTIVIST: Firms that invest more into lobbying will get more of those sweet government dollars. Those firms that are already well connected to politicians will do well.

COMPLIANT: Firms that are good corporate citizens will do better. So it will pay off especially to keep on top of your taxes, engage in Public Private Partnerships, contribute to social goods.

DEBT-LIGHT: Firms that have relatively low debt compared to competitors in their sector will do well because debt will be way more expensive going forward.

SERVE-THE-YOUNG: Inflation effectively robs the rich (who are usually older) and gives to the poor (who are younger). Old rich people lose some of their wealth but young people (and immigrants, and those less well off), who have few assets will mainly see their incomes rapidly rise. As a result, companies who serve young people (with few assets) will do better than those who serve rich old people.

Russell indicates that gold is likely to do well: “Gold will do well once people realise that inflation won’t come down to pre-2020 levels but will settle between 4 and 6%.”

I would add that some crypto assets will be a good investment for the same reason as gold. Not all crypto, but those crypto assets which have fixed supply, most notably Bitcoin. Etherium might be especially well placed if they stick to the plan to burn ETH with every transaction decreasing the total amount of ETH, and thereby increasing the value of each remaining coin.

That said, crypto is only a good investment at the right price. It’s hard to say how much of today’s price is based on short-term speculation. Arguably, it’s relatively low as I write this at the end of 2022. But overall, over the 15-20 year horizon, given the probable 60-80% inflation over that period, an asset that is guaranteed zero inflation (BTC), or even negative inflation (ETH), looks attractive.

Russell warned against government bonds: “Avoid government bonds. Investors in government debt are the ones who will be robbed slowly.” Normally (e.g. between 1980 and 2020), bond yields would get too high if inflation was too high, but this won’t happen going forward:

“You need a domestic investor base that is captured by the regulatory framework and has to buy your government bonds, regardless of their yield. This way, you prevent bond yields from rising above the rate of inflation. All this is in place today, as many insurance companies and pension funds have no choice but to buy government bonds.”

I would add that not only do you have to avoid bonds in your own portfolio, you need to also avoid exposure to those who will be harmed the most when their bond investments don’t pan out. So for instance, big government pension programs (which have lots of government bonds) will be severely short of cash, which means retirees won’t get their full pensions, which means retirees will have to cut their spending, which means businesses serving retirees will do poorly. It’s worth playing out the 2nd and 3rd order effects for this new investment environment.

It’s not outlined in the article, but this youtube lecture describes what’s coming for the Euro area. In particular, how the Euro can’t possibly work in this new scenario where 27 individual governments are guaranteeing credit (thereby creating money/inflation) in an uncoordinated way. Russell indicates the problems will hit Euro countries harder and sooner than, for instance, the US/UK/Japan.

I agree that Euro-area countries have a high risk of catastrophe. Euro-area countries might be in a “tragedy of the commons” type problem whereby 27 nations have the power to cause harm mainly to the others and there isn’t a strong enough structure (e.g. European governance) to prevent it.

The USA seems better placed not only because it has a strong federal government, but also because it’s still the world's reserve currency. This last fact seems to be starting to change (maybe the Yuan, maybe Bitcoin), but seems unlikely to me to radically change, even over the next 20 years.

Russell also warned against investing in countries/currencies that are likely to need to enact capital controls (meaning you may not be permitted to exchange it).

“Switzerland, for example, will probably stay away from these policies, but it will see continued inflows of capital, creating upward pressure on the franc. Sooner or later, Switzerland will have to bring back some forms of capital controls. That will be a feature worldwide.”

I got a lot out of this article as well as Russell Napier’s YouTube lectures and interviews (no channel, just search for his name). If I’ve piqued your interest, it’s well worth your time to explore further. He tweets under the Library of Mistakes and is worth a follow.

He’s identified a fascinating and what seems very likely path. I wish it weren’t the path but if it is, I feel much better prepared not only to weather it, but make the most of it.

Go back to the main page.

Cover image by Oberholster Venita from Pixabay

All quotes throughout this blog post come from the article “We Will See the Return of Capital Investment on a Massive Scale” by Mark Dittli on themarket.ch published 14-Oct-2022. It’s well worth a read.

—

I read this thought provoking article which was an interview of investment strategist and historian Russell Napier. I was so enthralled by his article that I did something I never do: I watched youtube. Just to glean a little more insight from a brilliant thinker. Russell argues that: “Many investors today still pretend that we’re in the system that we had from 1980 to 2020. We’re not.” And he predicts that we’ve already moved into an investment climate similar to what was in place starting at the beginning of World War II:

“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….This is nothing new, as it was the system that prevailed from 1939 to 1979.”

What he describes is especially applicable to Western economies. In particular those that are heavily indebted (Japan, Southern Europe, USA).

He has solved one of the biggest things I’ve been puzzling about lately. Governments have spent atrocious amounts of money first because of Covid and currently because of Putin and it can’t be possible to keep going on like this. So, what will governments do to get out of all of this debt they’ve accumulated?

Russsell gives an answer: with credit guarantees to commercial banks. Here’s the short of it:

Step 1: A shift in control of the monetary supply. Central banks no longer control the money supply. That’s their job, but they’ve been neutered. Governments (politicians and bureaucrats) effectively control the money supply by guaranteeing loans issued by private commercial banks.

Step 2: Crises happen and the government solves them with money they create using credit guarantees. There’s always a crisis that the public expects the government to pour money into to solve. Covid, Putin, climate change are just the first. There will always be more crises for politicians to solve:

“the politicians in government will say they are elected to pursue these policies. They are elected to keep energy prices down, elected to fight climate change, elected to invest in defence and to reduce inequality”

Governments can’t resist using this powerful tool. So they will use it a lot, and importantly, mostly for their favoured causes.

“For the government, credit guarantees are like the magic money tree: the closest thing to free money. They don’t have to issue more government debt, they don’t need to raise taxes, they just issue credit guarantees to the commercial banks.”

Step 3: Repeat for 15-20 years. This will continue to work for a fairly long time because it will be popular with the public:

“People are screaming for energy relief, they want defence from Putin, they want to do something against climate change. People want that, and elected governments claim to follow the will of the people.”

Step 4: Economies bake in persistently high inflation. Because this tool (guaranteed loans) will get used so much, the economy will face steady, high inflation. But it most likely won’t cause hyperinflation.

We’re already well on our way. The pattern was first proved with covid responses in the West, but already the European energy crisis follows the same four step pattern:

“Out of all the new loans in Germany, 40% are guaranteed by the government. In France, it’s 70% of all new loans, and in Italy it’s over 100%, because they migrate old maturing credit to new, government-guaranteed schemes.”

Nearly all Western governments — and therefore the main trading/saving currencies — are pursuing this strategy (save, perhaps, Switzerland).

Good: Governments inflate away lots of debt - from 300% of GDP down to a more sustainable 200%.

“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”

Bad: Massive capex investments into favoured industries - good for those industries, but on net, not good for the economy because the bets won’t generally be economical. It will take a decade or two for the incompetence to show though.

“When the UK government did this in the 1950s and 60s, they allocated a lot of capital into coal mining, automobile production and the Concorde. It turned out that the UK didn’t have a future in any of those industries, so it was wasted and we ended up with high unemployment.”

Ugly: 6-8% a year inflation, every year for 15-20 years, means any person or company who has wealth is at a high risk of seeing it inflated away. The scenario Russell describes (6-8% for 15-20 years) would mean you lose 58% to 78% of your wealth. That means each $100 you have today will be worth as little as $21.45 in 20 years.

But this government-fueled spending spree can’t go on forever. So it won’t. The result will be stagflating economies in 15-20 years depending on the country / currency / quality of the investments / economy. Stagflation means high inflation plus high unemployment. The high unemployment comes because all of the capex investments will largely be invalidated by then as good investments.

Throughout the article, Russell lays out a few basics. Regarding equities he says:

Within equities, there are sectors that will do very well…This capex boom could last for a long time. Companies that are geared to this renaissance of capital spending will do well.

The article hints at several opportunities and risks for investment in this new investment era. I’ll expand (speculate?!) on Russell’s points.

Russell lays out that some sectors will get massive investment: "The great problems we have – energy, climate change, defence, inequality, our dependence on production from China – will all be solved by massive investment.”

I would add the following additional industries are also likely to do well: research, education, health. All of the industries Russell mentioned and I added are favoured industries by most governments. Why?

• Huge investments already go there. Perhaps because they’ve captured the government. This will only accelerate when more money is up for grabs.

• They’re all social goods. They’re all easily understood by the public and politicians. They’re an easy sell.

Beyond those industries there will be some effects from inflation itself. Those industries that require high long-term capital investments and who aren’t in favoured industries will really struggle. That includes anything Venture Capital (VC) funded, perhaps even tech startups like mine (though I hope we’re favoured!). Capital, both in terms of equity and debt, will be much more expensive over the coming couple of decades.

So that’s broad sectors, but individual companies within sectors will vary dramatically in performance due in this new era too.

The main determining factor of success for a company will be: are you favoured for government largess or not? Some firms will naturally be better positioned than others. All other things being equal, the winners will tend to be:

BIG: Larger firms are more legible to governments and will also be more effective lobbyists. They will get the meetings and be able to organise themselves. Tiny firms, or even collections of small firms won’t be able to organise themselves. Financial firms that are “too big to fail” will indeed not be allowed to fail.

ACTIVIST: Firms that invest more into lobbying will get more of those sweet government dollars. Those firms that are already well connected to politicians will do well.

COMPLIANT: Firms that are good corporate citizens will do better. So it will pay off especially to keep on top of your taxes, engage in Public Private Partnerships, contribute to social goods.

DEBT-LIGHT: Firms that have relatively low debt compared to competitors in their sector will do well because debt will be way more expensive going forward.

SERVE-THE-YOUNG: Inflation effectively robs the rich (who are usually older) and gives to the poor (who are younger). Old rich people lose some of their wealth but young people (and immigrants, and those less well off), who have few assets will mainly see their incomes rapidly rise. As a result, companies who serve young people (with few assets) will do better than those who serve rich old people.

Russell indicates that gold is likely to do well: “Gold will do well once people realise that inflation won’t come down to pre-2020 levels but will settle between 4 and 6%.”

I would add that some crypto assets will be a good investment for the same reason as gold. Not all crypto, but those crypto assets which have fixed supply, most notably Bitcoin. Etherium might be especially well placed if they stick to the plan to burn ETH with every transaction decreasing the total amount of ETH, and thereby increasing the value of each remaining coin.

That said, crypto is only a good investment at the right price. It’s hard to say how much of today’s price is based on short-term speculation. Arguably, it’s relatively low as I write this at the end of 2022. But overall, over the 15-20 year horizon, given the probable 60-80% inflation over that period, an asset that is guaranteed zero inflation (BTC), or even negative inflation (ETH), looks attractive.

Russell warned against government bonds: “Avoid government bonds. Investors in government debt are the ones who will be robbed slowly.” Normally (e.g. between 1980 and 2020), bond yields would get too high if inflation was too high, but this won’t happen going forward:

“You need a domestic investor base that is captured by the regulatory framework and has to buy your government bonds, regardless of their yield. This way, you prevent bond yields from rising above the rate of inflation. All this is in place today, as many insurance companies and pension funds have no choice but to buy government bonds.”

I would add that not only do you have to avoid bonds in your own portfolio, you need to also avoid exposure to those who will be harmed the most when their bond investments don’t pan out. So for instance, big government pension programs (which have lots of government bonds) will be severely short of cash, which means retirees won’t get their full pensions, which means retirees will have to cut their spending, which means businesses serving retirees will do poorly. It’s worth playing out the 2nd and 3rd order effects for this new investment environment.

It’s not outlined in the article, but this youtube lecture describes what’s coming for the Euro area. In particular, how the Euro can’t possibly work in this new scenario where 27 individual governments are guaranteeing credit (thereby creating money/inflation) in an uncoordinated way. Russell indicates the problems will hit Euro countries harder and sooner than, for instance, the US/UK/Japan.

I agree that Euro-area countries have a high risk of catastrophe. Euro-area countries might be in a “tragedy of the commons” type problem whereby 27 nations have the power to cause harm mainly to the others and there isn’t a strong enough structure (e.g. European governance) to prevent it.

The USA seems better placed not only because it has a strong federal government, but also because it’s still the world's reserve currency. This last fact seems to be starting to change (maybe the Yuan, maybe Bitcoin), but seems unlikely to me to radically change, even over the next 20 years.

Russell also warned against investing in countries/currencies that are likely to need to enact capital controls (meaning you may not be permitted to exchange it).

“Switzerland, for example, will probably stay away from these policies, but it will see continued inflows of capital, creating upward pressure on the franc. Sooner or later, Switzerland will have to bring back some forms of capital controls. That will be a feature worldwide.”

I got a lot out of this article as well as Russell Napier’s YouTube lectures and interviews (no channel, just search for his name). If I’ve piqued your interest, it’s well worth your time to explore further. He tweets under the Library of Mistakes and is worth a follow.

He’s identified a fascinating and what seems very likely path. I wish it weren’t the path but if it is, I feel much better prepared not only to weather it, but make the most of it.

Go back to the main page.