BRENT JOHNSON: Well, hello, everyone. This is Brent Johnson from Santiago Capital, and I'm back here on Real Vision. And I just have a real privilege today. I have the opportunity to speak with somebody who I've followed for a very long time, and I've communicated with him a few times over the years over email, but I've never actually spoken to him before. And I just can't tell you how excited I am and how much I've been looking forward to it.
And so with that, I'd like to welcome Russell Napier to Real Vision. Welcome, Russell.
RUSSELL NAPIER: Thanks, Brent.
BRENT JOHNSON: One of the reasons this is such a treat for me is, I have to say, I read a lot of, research I follow a lot of different people, listen to their interviews. But out of everybody that I follow on a consistent basis, you're probably my favorite. So I'm a fan. I've just got to tell you that right up front so that there's no hiding it.
And I think one of the reasons that I find you interesting and like your stuff is I'm not really sure what to call you. You're a strategist, you're an analyst, you're a portfolio manager, you're an author, you're an entrepreneur, and you're a Scotsman. So what's the right thing? What's the right way to refer to you?
RUSSELL NAPIER: Well, that's good. So the first thing you mustn't do is call me a Scotsman, because you'll get all the Scotsmen really upset. So I come from near Belfast in Northern Ireland.
BRENT JOHNSON: Ah! Okay.
RUSSELL NAPIER: But I have lived in Scotland for nearly 30 years. So it may be wearing off. But I've got friends who are Scottish we get really upset when people call me a Scotsman. I don't find it offensive, but they do, so anything anything except a Scotsman is really what you should call me, but it's up to you.
BRENT JOHNSON: Got it, got it. Well, one of the other reasons that I like reading your stuff is, it's not just that you're smart, and intelligent, and all that stuff, but in my opinion, you're a very, very good storyteller. And someone who's a very good storyteller in finance I particularly like, because to me, when you just read a bunch of data or a bunch of numbers, sometimes it's hard to internalize it. But the way you write your stuff, it helps me remember it better.
So maybe that's one of the reasons I like it. But in all of your stuff, you throw in a little historical anecdote, a little humor, but then you always have the data to back it up. So I think it's fantastic. Did you study history at some point? Is that how you came to that style of writing?
RUSSELL NAPIER: Well, my friends might say, of course, I'm from Northern Ireland, I've lived history. So that's one way of getting to a bit of history. But I just want to pause on that word "storytelling," because I think it's a great phrase, and it's a phrase that, in our business, people look down on-- when you say you're a storyteller-- because it's a marketing thing.
But stories are really, really important because they are so much more than the data. And I think it's a skill that is really underrepresented in our business and looked down on. But the problem for everybody in our business, particularly in the modern era, is yes, it's finance, yes, it's accountancy, yes, it's economics, but it's also sociology.
I mean, you've just lived through a remarkable election in America, which is as much about sociology as anything. It's about politics. And if you want to put all that stuff together, you can't do it in an equation. And a story may be the better way to do it.
Now, the stories can be wrong. The stories can be inaccurate. But to pretend that isn't a story, to prevent the future, which is-- I can't say it's unknowable, or I'd be doing myself out of a job. But we'd better tell the future in stories, because the more we tell it in equations, the more dangerous it is definitely going to be.
So I think stories are very, very important, and that it's important for all of us, when we try to work out investment, that we are cognizant of very many forces beyond, if you like, just economics that drive and determine prices. So I am flattered and delighted that you think I'm a good storyteller, and I don't see it as an insult. I see it as a great compliment, that we need-- more like this.
BRENT JOHNSON: Well, I meant it as a compliment, and I've tried to follow your lead in that a little bit. And I don't think I'm in the same league as you, but I've definitely used your writing as a model for my own. So because I've read your stuff for a long time, I'm fairly familiar with your views. I'm still going to ask you a number of questions that I already the answers to, because I want the audience here to get to hear it straight from the horse's mouth. And I agree with some of the stuff that you're talking about, and then, I also know that I currently disagree with some of the stuff I've read recently, but it may just be because I don't fully understand your position.
So I'm looking forward to digging into that in a little bit more detail. I hope we have time to get through it all. I know you're a busy man and don't have tons of time, but I hope that we get to talk about this stuff, and I hope the listeners get some value out of it. Because I think what you're talking about right now is really of the Zeitgeist of the moment, and that's the whole inflation versus deflation debate.
And I think one of the important things-- I think one of the important things of you starting to talk about an inflation is that you were so much of a deflation asset for a long time. And so before we get into the current topic, I'd actually-- if you don't mind, I'd like to rewind five or 10 years and just talk about the deflationary environment that you correctly called for the last 10 years, when everybody else was saying green shoots, inflation, get ready for hyperinflation, failures of currencies, and you really stuck to your guns.
And so I guess what was it that five, 10 years ago that kept you as a deflationist? Why didn't QE work? Why didn't negative rates work? Why didn't the five arrows from Japan work?
RUSSELL NAPIER: Yeah, so I remember the day I changed my mind on this. And I was attending a conference in New York, actually, in the Plaza, where I'd tried to interview Paul Volcker. He's very good at not answering questions.
But we were surrounded by commercial bankers, and I began to realize just the challenge that commercial bankers were going to have in growing their balance sheets, regardless of the policy of the Federal Reserve. The most important thing for anybody watching this to know is that it's commercial banks who create money and not the central bank. The central bank-- and I think this is a really helpful analysis-- it's like a coachman or a coach woman driving a team of horses. But the six horses in front are commercial banks. And the reins they have that run from the coachman to the horses are the reins of interest rate, the reins of central bank balance sheet size, and sometimes, they also control capital adequacy rules.
And those are the reins. And by steering, they use those to steer the horses to create money. And what I thought was right is that it wasn't going to work, that they simply weren't going to work. There were all sorts of reasons why commercial bank balance sheets weren't going to expand. And ultimately, if they didn't expand, no matter what the central bank did with its own balance sheet-- which we all know has been going like this-- in terms of broad money-- which is the money that we have in our pockets that we spend every day-- it really wasn't going to go up. And that was one reason for being on the side of deflation.
Well, there was another reason, and that is that the interest rate policy that they pursued in full in quantitative easing was creating a huge boom in non-bank debt, and the debt-to-GDP ratio was going up. Now, that varies from country to country, but basically, it was going up. So they'd actually devised a policy that was guaranteed to do the reverse of what they wanted it to do. It was not creating any growth in broad money, but it was creating growth in debt.
And, I think as everybody watching this would probably know, if your debt keeps going up, and your nominal GDP doesn't go up, you're weakening your balance sheet. You're not strengthening a balance sheet, preparing it for when the next recession comes, to be more robust. You're preparing it to be less robust. So those were the crucial reasons for saying that this isn't going to work. It's because the commercial banks weren't doing.
Now, things have changed, which is, I think, what we're going to come onto. But America was more successful in this than elsewhere, but was largely unsuccessful. Some places, such as the European Union, were completely unsuccessful in this, and that's why they've got themselves into an even bigger mess than the United States of America.
BRENT JOHNSON: So along those lines, the goal of QE is to pull interest rates lower. And we have had low or very low, and then, in Europe and Japan, negative rates for many years. In your opinion, are low rates inflationary, or are they deflationary? Because I think in my opinion, that's something people get wrong sometimes.
RUSSELL NAPIER: Yeah, so I've explained the situation in which they can actually be deflationary. And then, the way we could have low interest rates being deflationary is they don't create any more money, but they create a lot more debt.
BRENT JOHNSON: Yeah.
RUSSELL NAPIER: So monetary policy is about the quantity of money, full stop, not the price of money. The price of money is a technique to adjust the quantity of money. And what they manage to pull off was a price of money which adjusted the quantity of debt without adjusting the quantity of money. And that's deflationary; it's not inflationary.
You might say, well, why did they not change that policy? And I guess that's folklore, isn't it? To a man with a hammer, every problem is a nail. And they had a hammer, so they saw this problem as being a nail. And they come up, and they hit it with a hammer.
BRENT JOHNSON: Well, is that also a function of the design of the monetary system and, then, the laws that the central banks have to operate under? Because for the system to work, money has to grow there. Has to be ever extension of credit. If credit is not extended, by design, the system will fall.
But central banks are only allowed to lend, right? They're not allowed to print-- at least not yet. And so the fact that you've got these low rates that are caused by too much debt, and the only way that they can fix it is adding to the debt, it's this deflationary spiral. And I think you are one of the people that helped me understand that.
So again, I'll say thank you. But the interesting thing now-- and, I guess, so it's probably time to shift gears here a little bit-- is two or three months ago now-- well, actually, you started hinting at it in the spring. And then, two or three months ago, you actually said, inflation, get ready for it.
And I wasn't totally surprised, because you had started hinting about it. But I was a little surprised at the speed with which you said it. Were you surprised by the speed with which you said it?
RUSSELL NAPIER: So the first thing I'd say is I think there was a better solution than quantitative easing. And this will sound very technical, but it was the re-intermediation of credit assets. And what could be more boring than the re-intermediation of credit assets?
BRENT JOHNSON: [LAUGHS]
RUSSELL NAPIER: But if we'd done something that persuaded the banks to buy back in existing credit, then their balance sheets would have expanded, and they would have created money. And by "existing credit," that's, obviously, government debt. But there's a hell of a lot of private sector debt out there, whether it's MBS or corporate bonds.
So that's the policy I would have pursued, rather than quantitative easing. And I think if you buy existing credit assets, at least directly, you do not increase the level of debt, but you do increase the level of money. So that's rather technical, but I think there were tools in the toolbox of the central bank other than quantitative easing. They didn't use them. They got it wrong. We are where we are.
Am I surprised how quickly I changed my mind? That's the thing about what I do, is that I don't change my mind very often, but where you're going to change it, you'd better do it quickly. And I remember very well back to that particular bank conference, because I'd been there the week before saying one thing, and I was back the next week saying exactly the reverse.
And people think, oh, you're very inconsistent. This is a terrible way to do something. But if you only do it every 10 years, it's not quite so bad.
BRENT JOHNSON: Yeah, right.
RUSSELL NAPIER: So the reason that I changed my mind-- and, I would say, two months too late-- is that I finally began to grasp the scale and magnitude of the government guarantee programs for commercial bank debt. And I wish I'd done it two months earlier, and I wish I'd seen it two months earlier. But also, you have to make that call, not just that it is happening-- and nobody can refute that it's happening. You have to foresee that it will continue to happen.
And I think as time has gone on, I just get more and more convinced that this particular manipulation of the commercial banking system by government-- which means they now control monetary policy-- is permanent and not temporary. So I wasn't really that surprised how quickly I changed my mind. I just wish I'd been smart enough to change it too much earlier and really see the significance of those first-- that first step across the Rubicon. Well, you can always jump back again, but it took a while to realize that this was the new-- this was a revolution. This wasn't just a step, this was a revolution.
So I could still be wrong on that, but I think what we're going to discuss is, really, why this is a monetary revolution.
BRENT JOHNSON: Sure, sure. And just for the listeners at home who are new to finance, and they're still learning, the point we're trying to make here is that QE for the last 10 years, it expanded central bank balance sheets, and it gave a lot of reserves to the banks themselves, but the banks did not use those reserves as collateral to then loan into the market. So lending, broad lending, didn't take place, and typically, that's where most of the money supply comes from, is from money being lent by commercial banks. That didn't happen, so we had this deflationary environment where debt was growing, but money was not.
RUSSELL NAPIER: You've just [INAUDIBLE], Brent, because I think it's very easy for anybody watching to confuse the two things. There are two different types of debt, and it's really important to divide them into two. There's commercial bank debt, and there's everything else. So we know that as bond debt, commercial paper, corporate bonds, et cetera.
BRENT JOHNSON: Yes.
RUSSELL NAPIER: So what happened is the banks didn't lend, so they didn't create money, because that's what banks do. But meanwhile, this other great big pile of debt grew, and grew, and grew. So that's the kind of Catch-22 we're discussing here. You can't create more money unless you create more debt, but specifically bank debt. The problem is they created the wrong sort of debt. They didn't create the sort of debt that also creates money
So to solve the problem, maybe what you do in a society that, let's say, was 50% bank debt and 50% non-bank debt, but if you've got the bank debt growing at 10%, then the money supply might grow at 10% And if you stop the non-bank debt growing at all, then you would have growth in money of 10%, but growth in debt of total debt 5%. So it's a bizarre-- and it's really difficult to wrap-- it's a bizarre combination of high more debt can reduce your debt-to-GDP level. It doesn't reduce your debt level, but it reduces your debt-to-GDP level. But the crucial bit is which bit is growing and which bit isn't growing.
BRENT JOHNSON: Exactly. And so as I mentioned earlier, you're one of the ones that helped me understand that years ago. And so I have been in the overall deflationary case, and I still am, on a global basis. I think we're going to talk about which comes first, or where inflation comes first here in a minute. But I remained in the deflationary camp, but I will say that what we're going to start talking about here is you've made the case to me, better than anybody else, of why I should start thinking the other way.
So that's why I think what we're going to talk about next is so important, because what you're saying now-- and I'm going to let you explain it-- is that there has been a change. There is actually going to be bank lending. And that is going to push the GDP higher, or potentially push GDP higher. More money will be available. And so the crushing of the debt isn't there.
So again, I don't want to put words in your mouth, but why don't you explain for the listeners this Rubicon that has been crossed and why the banks are going to start lending?
RUSSELL NAPIER: OK, so let's say nothing I'm about to say now is a forecast. This is all in the past. Everything I'm about to talk about has already been done. It's not a forecast.
So what they're going to happen in the spring of this year is that governments, really, across the world, and almost without exception-- likely, they were acting in unison-- suddenly decided that the best thing to do to keep the people and businesses alive during COVID-19 was to get credit flowing through the banking system to people who needed it. Which, if you think about, is really pretty smart, because everybody's got a bank account. So if you needed to get money down into the very corners, to the guy who runs a taco stand, for instance, that's how you would do if. And you did it through the existing financial system. And in America, you did it through your Small Business Administration, but also through the banking system.
So what we have to grasp is how that changed everything. Now,