This month our favorite read was an interview (which we highly recommend you read) with Russell Napier, perhaps the world’s top financial historian. For decades, Napier correctly forecasted disinflation as the dominant force in financial markets. He pointed to themes such as aging demographics, cost-saving technology, cheap Chinese exports, increasing debt burdens, and the decline of the velocity of money as key deflationary factors

However, last summer Napier warned US investors should prepare for 4%+ annual inflation rates throughout the 2020s. Two key changes caused his pivot. The first was the rapid growth of the money supply despite the country being in the worst recession since World War II.

The second change was the US government in 2020 intervening in the commercial banking system by telling commercial banks to grant loans to companies. The US Treasury guaranteed loans such as PPP, completely circumventing central banks. As a result, politicians, not central bankers, now control the money supply, and they need inflation to get rid of high debt levels. Napier argued that now that politicians have the tools to create inflation, they will use them.

One Year Later

Now that one year has passed from Napier’s predictions, we find core CPI soaring to 5.4% as of July 13th, 2021.

Most importantly, Napier is now predicting that despite the rise of inflation, “Interest rates will not be allowed to reflect that rate of inflation. That is what changes the entire structure of finance...This is because we will be entering a period of financial repression, where governments keep interest rates below the rate of inflation, just like after World War II.”

For the last 40+ years, bond yields have accurately reflected the inflation outlook. Now they are no longer in a free market, depressed by central bank purchases and regulatory requirements for banks and insurance companies to hold them.

Napier predicts that central bank monetary policy will become increasingly irrelevant versus government fiscal policy. Central banks will jawbone as if they are in control, and it will work for some time because the market is so conditioned that the Fed is the dominant force.

In the short-to-medium term, equities and real estate prices should benefit as wealth will increasingly transfer from savers to debtors. After a few years, the government will cap bond yields, and only then will the masses wake up to the new inflationary paradigm.

Interest rate caps will lead to the misallocation of capital, which typically leads to high inflation and high unemployment, i.e., stagflation. And that’s when limited-supply assets like gold and bitcoin should outperform.

We find Napier’s views particularly compelling as we participate in the investing arena. Place your bets...

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