RussellNapierMacroVoicesErik:     Joining me next on the program is Russell Napier, financial historian and the founder of the investment research platform, ERIC.

Russell, thanks so much for joining us again on the program. Last time we had you on was back in May of last year. At that time, you told us that it was likely that there would be continued weakness in the Treasury bond market because, for the first time in many, many years, private savers had to finance what had become a situation of central banks being net sellers of Treasuries.

And, needless to see, we did see a big move up in Treasury yields since then, all the way up to 3.25%. Now it’s started to turn around. And I remember you also cautioned us – you said a lot of people really were convinced of an inflation prognosis. You said you thought that was not going to last.

So, as I see bond yields turning around, does that mean that the market is catching up with your expectation that deflation rather than inflation would rule the day? And where do you see Treasury yields going from here?


Russell:            I think we have reached a tipping point. Back to that original prognosis, when you see an incredible surge in the supply of Treasuries, the easiest forecast to make is that the price has to go down and the yield has to go up.

And, remember, that surge in supply comes from two sources.

One, the United States Treasury. The fiscal deficit has effectively doubled over the last five years, so it is nearly $1 trillion. It was less than 1/2 a trillion in 2014.

And, of course, the second source of supply is the Federal Reserve. And that will be up to about $360 billion this year. Total, roughly $1.3 trillion.

So we’ve never seen anything like that before. And as soon as I give you those supply numbers, the temptation is to say, well, yields have to go up.

However, that has not been happening for the last few months. And the reason is, I believe, that the Treasury yield is probably the most reflexive financial instrument on the planet. Remember that Soros definition of reflexivity.

It’s the reverse of the business school definition of how security prices are determined, which is those prices are determined by looking at the fundamentals. The Soros view is that sometimes – not all times – but sometimes the security price changes the fundamentals. Now that could never be more true than the US yield curve and the level of US interest rates.

And I think what message we got about two months ago is that at the levels of interest rates then pertaining there was ample demand for this massive supply of Treasuries. But, crucially, it forced the liquidation of other securities from somewhere else in the world.

That’s why the equity market was going down. It was forcing a liquidation, whether in offshore equity markets or the local equity markets, to cover this massive supply of Treasuries.

Now, if the fundamentals are changing, which is not just the price of equities but economic fundamentals, if growth is slowing somewhere – it doesn’t have to be in America, it could be in China, it could be in Europe. But if that move in US rates is playing a role in slowing growth somewhere, then it’s creating its own fundamentals because, clearly, it’s creating a fundamental for lower growth and lower inflation.

And I believe that is the phase we have now entered.

So despite not forecasting this huge supply – because you don’t have to forecast it, it’s almost certain to occur – despite that large supply, I think what happens as we liquidate other savings assets to buy the Treasury, the Treasury yield continues to decline. And, more importantly, by liquidating private sector assets, we begin to slow global private sector growth.

Erik:     So, slower growth continuing, lower Treasury yields. Let’s tie China into this story. How does China affect this just on its own? And then how do the US–China trade relations and the negotiations that are ongoing between President Trump and President Xi play into this whole story?

Russell:            We can separate China into two: monetary effect and then we can get to the trade. They are linked.

It’s really essential to consider China’s role in funding the United States government, and that currently is zero. It hasn’t been zero forever. As you are aware, really since devaluation of the RMB in ’94, China was a massive buyer of Treasuries all the way to 2014. So not only did we have a much smaller supply of Treasuries, we had a guaranteed forced buyer.

The PBOC never woke up in the morning and chose to buy Treasuries. It was forced to buy Treasuries. That was a residual of its exchange rate policy. But it’s reserves were down. And they may be fluctuating a little bit, but they’re certainly not growing at the pace they used to grow at.

So the PBOC plays no role now in financing the United States government. It’s very hard to get clean numbers on this because of the way the PBOC buys themselves Treasuries these days. But it’s certainly possible, given the recent trends in their foreign reserves, that actually they might be adding to the supply of Treasuries to the private savings sector. Because they may be, at the margin, more a seller than a buyer. So it plays into this dynamic.

If we take away a guaranteed buyer – whether it’s the PBOC, whether it’s the Saudi Arabian Monetary Authority, whether it’s the Bank of China, whether it’s the Bank of Korea – if we take away those guaranteed buyers (and remember, those buyers funded their purchases of Treasuries by the creation of new money, not by liquidating another savings asset), then more and more of the burden of funding the US government falls upon people (that’s you and me) who could only fund the US government by liquidating something else or saving more.

So the economic impact of the PBOC not being there is actually quite profound, because it’s forcing a realignment of savings for the first time. And that’s been underway since 2014, so it isn’t new.

What is new, of course, is what we referred to earlier: a massive increase in the supply of Treasuries. So the fact that they’re not there and we’ve at least doubled the supply of Treasuries, I think, has a profound impact.

But I want to stress over and over again that the impact is that other assets have to be sold to fund the government. And that’s what we should be looking for that to play out.

So that’s the impact on the Treasury market.

Domestically, of course, what it means is that if China’s foreign exchange reserves are not going up – that’s its central bank’s key asset – its liabilities are also not going up. And, remember, the liabilities of a central bank are, effectively, what we call quantitative easing.

So, actually, China’s involved in quantitative tightening. It’s not deliberate, planned, managed, and voluntary quantitative tightening like the Fed is pursuing. It’s an enforced quantitative tightening, because when its assets come down its liabilities have to come down. And those liabilities are primarily commercial bank reserves.

So there’s two negatives there for the world. One, the saver has to take up more of the strain of funding the US government if the PBOC isn’t there. And, two, that’s a tighter monetary policy.

Now, I know the world is convinced that China is running a looser monetary policy. And China can proclaim all it wants as to what it intends to do, wants to do, and wishes to do. But, when you run that exchange rate management policy, your monetary policy is forced upon you.

In the lack of often an external surplus they’re being forced to tighten monetary policy. I think it’s evident in the contraction in commercial bank reserves which has now been underway in China for about a year.

And, finally, on trade, the key way trade plays into this is China desperately needs an external surplus of some sort. That’s how it can have exchange rate stability and, at the same time, print a lot of money and grow.

But I think, whatever the outcome of the deal between China and America, it’s incredibly difficult to see that being positive for China’s trade account. The President of the United States has gone looking for concessions. I think he’s going to have to get some concessions. We can all argue as to what concessions they would be.

As to how that would work to the benefit of China’s trade account, I think that is the least likely outcome from this. And to the extent that China’s trade account deteriorates and its capital account remains static, then we are looking at further tightening of Chinese monetary policy.

Erik:     So further tightening of Chinese monetary policy (coming back to our previous discussion about the US situation), you said it’s basically forecasting a slowing of global growth.

So is this a global recession signal that we’re receiving? And at the moment it looks like we’re seeing a bounce in equity markets from the lows that we saw over Christmas. Is that likely to turn back down as we need to liquidate more private assets in order to fund government spending and government deficits?

Russell:            Yes. A lot of the reason for the enthusiasm in the last few days has been the comments of Jay Powell last week. There is one thing Jay Powell could do to sustain the bounce in the markets – I don’t think a bull market, but a sustained bounce – which would be to cancel his balance sheet contraction.

Now, if you want to take last week’s comments as being of that magnitude – I don’t think they were at all – but if last week’s comments mean anything is bullish, it would have to be that. Short of that, I don’t think it makes any difference.

So I don’t believe he committed to that last week. I don’t believe he made any indication that that is more likely. And therefore I don’t believe the comments last week are ultimately particularly important.

What I would like to stress, and I’ve stressed before, is this is about China. This is not about America. What is going on here is 100% about China.

We like to believe that the Federal Reserve is the world’s most important central bank, but it isn’t. The People’s Bank of China is.

Remember, the Fed will set its nominal interest rates based upon its inflation expectations. So the most important central bank in the world is the central bank that dictates global inflation, because all the other central bankers, inflation targeters, will have to move nominal rates to reflect global inflation.

Now I would argue very strongly that the key that determines global inflation is the world’s second-biggest economy, China. Not just because of its rate of growth, but because of its rate of investment. Also, because its exchange rate was very overvalued for nearly 20 years.

And the overvaluation of its exchange rate – and its need to slow at the current exchange rate – means that we are looking at slower growth globally, tighter monetary policy globally.

And the focus should really be on that dynamic: what’s forced upon China, rather than what decisions Jay Powell might make.

We can get the decisions of Jay Powell wrong, that’s a common thing. But I think if we focus on the overvalued Chinese exchange rate, it’s very difficult to see how they get out of that particular pickle.

And that one is much more important, I believe, than changes in the views of Jay Powell.

Erik:     Speaking of changes in the view of Jay Powell and the rest of the FOMC, until recently, there was widespread expectation that there would be several more rate hikes through 2019. And, between the dot plot and the eurodollar futures spreads, everybody was anticipating plenty of more rate hiking to come.

It seems like we’ve seen a total reversal now in sentiment, in that most people now are discounting –

Maybe the question is not how many more hikes but when does the first cut come?

So is this change in sentiment just catching up with something that was already going on in the market? Or is the sentiment change overreacting? Are we really seeing a dovish pivot where the Fed is maybe moving back toward, at some point, responding to market conditions by cutting policy rates again? Or where do you see this headed?

Russell:            I never believed that Fed rates were going to march up 2019. Even last night when we discussed this I used the word “deflation” quite openly – more focused on deflation outside of America and credit crisis outside of America. I think we were focused on Turkey. So that is where the pain will fall.

And it was very difficult for me to believe that, in a world as what I saw as slowing growth and falling inflation and credit crises (it turned out there was one in Argentina as well – there’s been a myriad of them, by the way, across Africa, and they are spreading even as we speak), that US interest rates would continue to go up.

In fact, on May 8th Jay Powell spoke and said that this impact outside of America would have no impact on his monetary policy. That may still be true. What should have an effect on his monetary policy is he’s not actually creating a lot of money.

Now, I realize that there are a lot of people who listen to that statement and saying, that’s a form of madness to make that statement. But broad money, which is the money that circulates around the economy for goods, services, and has a huge role in GDP, has been slowing dramatically in America and, really, across the planet – very dramatically in emerging markets.

In China it’s at a new post-war low. It’s down in Europe, it’s down in Japan, it’s down in America.

And the market was sitting back, saying, well, we’re looking at a tightening here. Purely at the jobs market more than anything else, tightness in the jobs markets – a little bit of wage inflation – and completely ignoring the money supply data, which has been getting worse, and worse, and worse for about a year to a year and a half.

That is the reality. It’s very difficult to buy into a world of more growth and more inflation and higher asset prices in world where the growth of broad money is getting lower, and lower, and lower.

So the Fed is reacting to that. And, as I said, one of the crucial things about this is balance sheet issues. We can look at the P&L, which is growth.

But this is not a robust global balance sheet we’re looking at here. The total private sector non-financial debt-to-GDP ratio, the world is at a new all-time high. And, from memory, it’s gone from 210% of GDP at the end of 2007 to 242% today. So we’re looking at a more fragile system.

I would say, particularly outside of the US rather than inside the US, we’re looking at slowing growth. And the movements we see in interest rates at the long end – and now also with changes at the short end – just reflect this reality.

So 10 years of extreme and exceptional monetary policy, and we’ve got some of the lowest levels of broad money growth ever recorded.

Erik:     So you, as the man who literally wrote the book on bear markets, how do you interpret all of this, bringing it together in terms of a forecast or outlook for developed and particularly US equity markets?

Is this a bear market rally that we’re experiencing right now? And what would you see the rest of 2019 bringing us in terms of equity market action?

Russell:            So, by only focusing on four bear markets – and I clearly focused on exceptional circumstances and not the traditional definition of a bear market, which is every 20% correction – but what I would say about all four of those valuations were incredibly cheap, below 10 times CAPE, and we’re currently close to 30 times CAPE. How on earth could any equity market fall that far?

Well, history is very clear: deflation, for these four big ones. Not the average bear market, but for the big ones, it was the deflation. And deflation is falling cash flow.

And that’s why it’s important for equities and the falling cash flow, should it occur, it can threaten the very existence of equity. If you’ve got a very geared balance sheet. That is true of the United States – a very geared balance sheet.

The non-financial corporate debt-to-GDP ratio is at a new all-time high, just gone above its 2007 level. So it’s a vulnerable balance sheet. But the most vulnerable balance sheets, I think, to deflation are outside of the United States of America.

So if we do think that this monetary policy has failed to generate the level of money growth commensurate with inflation and growth, and we’re rolling back over into no growth and a risk of deflation – once again, I stress more likely outside than inside the United States of America – then this is a very big bear market.

And anybody who forecasts anything needs to look at the disease and the cure.

This is a disease which may, in fact, not be as bad as 2007. But the cure is used up.

I know that our central bankers are always finding new and innovative cures, but this one didn’t work. It simply didn’t work. It stopped the collapse of the global financial system, absolutely correct. But did it prevent a surge in the debt to GDP ratio? No, it didn’t. Because it simply failed to create enough money.

So the risk going forward is that people are not so frightened of the disease, but wonder if there is a monetary cure, at least. And I think that would be the most frightening thing for investors who spent nearly 10 years, now, being told that buying on a dip is always the way to proceed because the central banker always comes and bails you out.

And I believe – and I’ve said it for some years – that one day that central banker arrives and he doesn’t bail you out. It doesn’t work.

And I would argue that, in Europe in particular, that is the evidence. I mean, European equities are below 2007 levels, they are below 2014 levels, they’re not far away from their 2011 levels. In fact, the EAFE Index (i.e. the whole world except the United States of America) is very similar.

So outside of the United States of America there is really quite a lot of evidence that this magic wand of central banking does not create any magic.

Erik:     Let’s talk a little more about how that would unfold. Let’s suppose that what we’re about to learn here is that this experiment of the last 10 years proved that you can, in fact, paper over your problems and delay the inevitable by conjuring money out of thin air.

But there’s still no free lunch. The piper has to be paid eventually. And there is going to be a consequence for all of this loose monetary policy. It’s going to come back and haunt us.

If that’s true, how would it come back and haunt us? What would it look like? What would the mechanisms be? And what kind of feedback loops would develop in terms of creating a new bear market from here? How would it all play out?

Russell:            Just to be clear, the failure was that this monetary policy created debt much more quickly than it created money. So that’s the failure. And we can all look at how much money it created. But, you know, all the statistics from the BIS show that it’s been creating debt even more quickly.

The BIS also look at how you would analyze their debt-to-GDP ratio to say when this becomes a problem. And they have done that. And what they’ve looked at is not the level of debt to GDP but the pace at which it grows. And then they single out back tested – certain countries where the growth in the debt-to-GDP ratio, which I believe is a consequence of this monetary policy, is at such a height and such a divergence from its long-term trend that you can expect something to give.

A financial crisis, a credit crisis, are the terms that they use.

The one country that jumps off the page from these statistics that screams something has to give is China. Now, its debt to GDP ratio is very similar to the United States. But the growth and the pace of growth is just at an alarming rate.

Now, I paused a little bit and I said “financial crisis, credit crisis,” because, frankly, I just believe China would devalue and print a lot of money rather than begin to suffer the consequences of having massive growth in debt rather than growth in money.

But that is the catalyst. I can give you lots of catalysts for another deflationary shock, but I can think of none more profound and dangerous and changing things for a generation than a change in the Chinese exchange rate. So I believe that that is coming.

I believe that China could not and will not move to a new link in the dollar. They will not politically get away with undervaluing the exchange rate again.

So we are looking at moving into a world where the renminbi is a flexible exchange rate. It should happen this year. And the initial movement of the renminbi is down.

That is deflationary, because the dollar selling price of Chinese goods comes down. It’s deflationary because of the impact it has on China’s competitors. And that’s where the deflation shock can come from. Most obviously, it will create bankruptcies amongst some of China’s competitors on their foreign currency debt. And – maybe we can get on to this later – but I think in the very long run it’s highly inflationary.

And, once China lets that exchange rate go, for the first time, I think, people begin to realize that the Fed isn’t determining global monetary policy. Because it doesn’t determine global inflation.

Believe me, with a flexible exchange rate and a truly independent monetary policy and a huge debt burden being inflated away, China will be ultimately – after that first adjustment in the exchange rate – will ultimately be generating global inflation for the next two to three decades.

Erik:     The things that you’re saying kind of concern me, Russell. If the biggest risk is in China – we know that China and the United States trade tensions are already very tight. The US president has been very aggressive. If China is going to experience economic difficulty and there is a transmission risk, that that economic difficulty will maybe bring down the rest of the global economy with it. That sounds to me like a recipe for further political tension between the governments.

Am I wrong to think that that’s a serious risk? And, if it is a risk, what are the financial implications? And what are the investment concerns that we should think about in terms of how further geopolitical tension between the United States and China (if that were to develop) how it might play out?

Russell:            We have a blueprint for what this means, and it comes from a speech given by Mike Pence in early October at the Hudson Institute in Washington, D.C., and I strongly advise anybody who’s listening to this should listen to that and hear it, if you like it, from the horse’s mouth as to what the relationship between the United States and China is.

And trade is a tiny tip of the iceberg, in terms of issues raised in that speech. Of course, it was pre-midterms. It was sabre-rattling. Were they were just trying to get leverage on trade? Well, listen to the speech; come to your own conclusion.

But it attacked China for theft of intellectual property, it attacked it for human rights, it attacked it for attacks on religions, it attacked it for interfering with Western democracy. In fact, it was very difficult to work out a thing that wasn’t attacked. Trade was just a very small part of the reasons that were brought up by the vice president for this change in relationship with China.

I’ve spoken to many people about that, some of them in the defense business, and all of them believe this is important. They all believe it’s profound. And many of them are prepared to go as far as saying this is the beginning of a new cold war.

Now that may be too extreme. But I think, Erik, we are both old enough to remember the last cold war. And here is something that you don’t do in a cold war –

Let’s go back to that last one: I don’t remember US institutional investors investing a lot of money in Russia. I think it was illegal. It didn’t happen. I don’t remember us doing a lot of trade with Russia. Once again, for the same reason. I don’t remember lots of Russians coming to visit us here in Edinburgh, nor coming to the United States of America.

If we enter a form of cold war – I hope it really isn’t as bad as that, and it may not be anywhere near as bad as that – but the degree of movement of capital, of goods, and of people that we currently expect between China and the rest of the world could not and would not continue if this is genuinely the beginning of a new cold war.

So investors are very loathe to get into geopolitics because 99 times out of a 100 it’s not relevant. What’s relevant are cash flows in corporations and the price you pay for those cash flows.

But China has become the second biggest economy in the world. And it’s become such an integral part of the global trading/economic system that, for a cold war curtain to descend upon China and the rest of the West, that would be phenomenally damaging for not just growth but financial stability – and particularly for the Asian countries that border China. It would put them in an incredibly difficult position. They have benefited from a generation of the American defense of the dollar while trading freely with China.

And if the Pence speech is in any way indicative of the future relationship, this geo-benefit will not be possible. It’s going to be one or the other, but getting both is very difficult.

So I absolutely – and I may be reading too much into the speech of Mike Pence – but there’s been plenty more from the US defense establishment since then to suggest that we’ve looked at a shift towards a more cold war.

And anybody who remembers the last one knows that that has dire implications for investors.

Erik:     Do you think that we have reached a point where the top is in for the equity explosion of the last 10 year, which I think you and I both agree has been fueled in large part by central bank largesse? Is it over?

Or is it possible that what happens next is markets really start to take a dive? Powell comes riding to the rescue and there is another round of QE or something and it takes us to still new all-time highs in equity markets?

Russell:            I would believe it’s over. But obviously that can happen. That second scenario is obviously a possibility.

And we can try and weight that possibility, but there was always a risk. You may remember, this time last year, one of the big topics of discussion was the melt-up, which is, as the rest of the world slowed, America would import lower inflation, allowing interest rates to stay low and American growth high. But in a low discount rate and a high growth rate, you get a melt-up in equity valuations.

As it turns out, in terms of equity valuations if not price, they actually peaked at the end of January and they’ve come down pretty significantly in America since then.

I just want to point out one thing: We are fixated with the American equity market. And we should be. It’s 58% of global market capitalization.

But the world is not in a bull market if you’re not in America. Once again, these EAFE numbers show there is no bull market. The EAFE index is – and this is about dividends reinvested so, if you want, slightly false – but looking at the capital market for EAFE in dollar terms, it is really not very far away from where it was 18 years ago. So this is very much about a US equity bull market.

There has been a bear market underway in most places in the world. And, certainly, since 2014 there’s been a bear market in emerging markets. European equities are below that level as well.

So we’re really talking about can America continue to do what it’s been doing at least since 2014? Arguably since much earlier, which is to continue to have a bull market as everybody else has a bear market.

My answer to that would be no, because at some stage what is out there in the rest of the world begins to infect America.

I’ve written recently that this may be like the late 1920s – that, through the 1920s, America had an economic boom and America had a stock market boom, but then things were pretty subdued outside of America. But eventually the economic problems of the rest of the world in the 1920s came home to roost and affect the United States of America.

The go-to book on this is the famous Golden Fetters by Barry Eichengreen, who argues that eventually the problems from the rest of the world have to impact America. The question is, is it happening already? Or have we got another six months to go?

It’s difficult to argue in such short-term time horizons. But my basic bet is that things are skewing so badly in the rest of the world that America cannot contain and buck the trend with an equity bull market when the rest of the world’s equity bear market drags on.

Erik:     Let’s talk about that scenario where America’s equity market does eventually take a more significant turn south from where it is already. A lot of people have talked about the Fed being “out of bullets.” Now that they have done so much already, they don’t have capacity to do that much more. And, of course, starting from very low interest rates, it’s hard to reduce them very much.

And I guess the counterargument to that is there’s no limit to how much QE they could do. And they can go back to zero interest rates or even go to negative policy rates.

What do you think? How much, if things really get bad – I guess what I really worry about is it feels to me like we’re going to have an awakening where, at some point, investors are going to realize, wait a minute, the Fed wants to have our back but they can’t anymore. It doesn’t work anymore because the Fed is no longer all-powerful because they’ve used up all their ammunition.

Are we really getting close to that point? Or am I just being paranoid to worry about that?

Russell:            I worry about that as well. And I’ll come to the reason in a minute, which has really to do with China and the lack of potency of the Fed.

But let’s be clear what the Fed has succeeded at and what it’s failed at.

It’s very, very clearly succeeded at massive price inflation. And, obviously, when you’re in the financial markets you tend to think that that’s success because it’s making you wealthier, it’s making your class wealthier. This is how we measure success. So therefore we tend to think, well, they’ve always got another something else they can fund, they’re always successful.

When they fail to create money, this is the crucial, crucial thing. They’re very good at creating narrow money, expanding their own balance sheet. Nothing can really stop them from doing that. But there’s screeds of evidence now that this has not fed into broad money.

So one thing they’ve failed in is broad money growth. And, ultimately, that has to have some role in economic activity and inflation. So I don’t think they’re as potent as the market seems to think they are, because they failed in that particular issue.

Now let me give you the scenario. It’s really the scenario from the Wizard of Oz. You’ll remember when Dorothy spots that the wizard is just a little man playing an organ behind a curtain. And here is the scenario in which I think the potency of the Fed would be massively questioned instantaneously:

China devalues. The Chinese exchange rate is allowed to float. It comes down. We have Chinese goods pouring out at lower dollar prices. We have bankruptcies in other emerging markets, as we did post the 1994 devaluation.

And any market practitioners could say, well, I don’t care what the Fed does. Because the Fed can have some role in dictating US economic activity, but the rest of the world is going into the tank and the Chinese are slashing all these prices. Then how potent is the Fed?

So I could make a long argument that, really, the PBOC has been determining global market policy for two decades. They’ve determined the marginal rate of inflation. Therefore, they’ve determined global nominal rates.

Nobody would agree with that, or few people would agree with that. But the day they devalue is the day that it becomes very, very apparent that, as powerful as the Federal Reserve is, and as infinite as its balance sheet can become, they are not the only player in establishing global growth and global inflation.

Erik:     Russell, you mentioned Chinese currency devaluation potentially having very, very significant consequences, and transmission risks into the rest of the economy.

What other currencies around the world should we be thinking about? And what are the risks there?

Russell:            Well there is one major currency in the world which is considered today by everybody to be a safe haven, but I do not believe it is, and that is the yen.

Now, why is something believed to be a safe haven? Well, capital flows into it when we have trouble. No one can deny that. And no one can deny that when there are problems in the world the yen tends to go up. So that’s the status quo. That’s the way it has traded.

However, there are two major problems for the yen.

The first one is the Fed is contracting its balance sheet, ECB has stopped expanding its balance sheet. There’s really no prospect that the Bank of Japan is going to stop. It’s going to continue.

I’ve made this analogy in the past, but it’s like driving three Ferraris all valued at half a million US towards the first corner. They’re all worth half a million until they come to the first corner and we discover that one doesn’t have any brakes. At which stage, the two that maneuver the corner are still worth half a million US where the other one is scrap value only.

Well, that was all theoretical because nobody else was braking. But the two big guys were braking. So we will see what impact it has as it becomes clear, I think, clearer and clearer and clearer that the Bank of Japan won’t stop.

Now, once again, back to the analogy we made earlier with the US, it’s fine for the central bank balance sheet to expand, but it isn’t really creating great growth in broad money. And I think that’s why the yen hasn’t reacted more negatively already, because it’s in the same boat as everyone else. They just can’t create money no matter how hard they try, or at least they can’t create very much money.

However, even so, I think time will tell that, when one balance sheet shrinks, one balance sheet stabilizes, and the other balance sheet keeps going like a rocket, there have to be implications for the exchange rate.

And then to that China thing. The whole of north Asia is incredibly vulnerable to a Chinese devaluation. So that is South Korea, Taiwan, and Japan. And it would be inconceivable that they would permit a rise in the exchange rate.

So I can’t tell you exactly what they’ll have to do about that, to get those exchange rates down, but the idea that they would sit by and watch as China devalues and they keep their exchange rates up – very, very unlikely indeed. So expect more concerted effort by the rest of North Asia to try and react.

Remember, there are two broad financial systems in the world.

There is the so-called free market system, which isn’t that free, but it seeks ultimately profit.

And then there is the North Asian model, which seeks, ultimately, the full utilization of resources. And in that model the policy makers always have to devalue because that’s the goal.

And they don’t really care if they make any money, but they have to keep the full utilization of resources, whether it’s people or factories. So if China devalues, there may be an initial spike up in the yen, but the Bank of Japan is going to have to get even more aggressive. And, therefore, I think the yen ultimately comes down.

And there is a big structural background behind this is one that’s been around for a long time. The Fed has shown it can reverse. The ECB can, I think, ultimately reverse as well. There’s lots of private sector savings that can buy euro-denominated government debt.

But Japan ran out of savings many years ago because its debt to GDP ratio was so high.

So the other two can stop, but the Bank of Japan is caught in that traditional trap which ultimately always leads to high levels of inflation. Nobody believes that in Japan, just because of the history of the last 30 years. But when you have a central bank that can’t stop, you will get to inflation eventually.

And the first financial market that has always sniffed that out is the exchange rate. So, despite the fact that it definitely trades as a safe haven currency, I think – particularly as we get a movement in the RMB – I think we will change our minds on what the yen represents.

Erik:     Let’s come back to the US dollar while we’re on currencies. The last time we had you on the program, your outlook was very much for a higher US dollar. And you have been proven right.

But now we’re coming into a period of time when there’s been this reversal of expectations around US monetary policy. Suddenly what everybody thought was three to four hikes is maybe going to be a question of how many cuts come in 2019.

Does that change the outlook for the dollar? Have we maybe reached a top here? Or do you still see the dollar moving higher?

Russell:            It doesn’t change it for me. In fact, it makes me more convinced that we’re looking at the dollar going higher. And you might think, well, that’s peculiar, isn’t it? I mean, how can we look at a lower outlook for US interest rates and a higher dollar.

First of all, and always, consider the interest rates wouldn’t be rising at the pace the market had considered anyway. But, remember, the real reason this is happening is not because of economic activity in the United States per se. It’s because of what’s happening in the rest of the world.

We are focusing on US rates alone. But the 10-year German Bund yield, just three days ago, was incredibly close to zero again. We have a negative 10-year back again on the JGB [Japanese Government Bond]. This is really about growth outside of America.

So, yes, growth, I’m sure, will slow. I’m sure US inflation will come down. I’m pretty sure the Fed will keep putting rates up. But things are getting much worse in Europe. They’re getting much worse in emerging markets. And it’s all about the exchange rate as the relative between these two things.

I can’t remember if we discussed it last May, but coming up this May we have the European parliamentary elections. And in those elections, the extreme left and the extreme right are going to do incredibly well. How well? Perhaps 40% of the entire representation of the European parliament will be extreme left and right. They have, according to Di Maio, the deputy prime minister of Italy, already agreed to collaborate.

This is not unknown for the extreme left and the extreme right to do, because they share one thing in common. And the one thing they share in common is they all want to bring power back to their sovereign parliaments and away from Brussels.

Now that is a constitutional crisis on a grand scale which cannot be good for the euro. It questions the entire existence of the euro when you’ve got a constitutional crisis of that magnitude.

So if currencies are relative, given what I said about the RMB, the yen, and this massive constitutional crisis coming for Europe, then it’s very hard for me to stand here and tell you that the dollar is going down. Just by default the dollar is probably going up.

And the key reason is the dollar is coming down and really nothing with our interest rates. And, much more existential than that, China has an overvalued exchange rate, which has tightened monetary policy. Europe is involved in a failed experiment to create a single currency. And Japan has run out of savings. Three structural reasons why these exchange rates should come down.

And the dollar has questions, the US political system has questions, the US economy has questions. But they are not on the scale of the questions that they’ll be asking when the fascists and the communists are running Europe.

Erik:     Well, Russell, I have always enjoyed interviewing you as well as listening to your interviews with other interviewers, because your background as a financial historian gives you just so much deeper and richer perspective on markets than most of the people that we hear in the press. And it’s just such a treat for me to have a chance to interview you.

An even better treat might be something that you are recently working to put together, which is a class called “A Practical History of Financial Markets.” And this is not just an hour-long talk at a retail investor conference. This is something that is designed for investment professionals and extremely sophisticated private investors. It’s two solid days.

Tell us, how did this come about? It’s absolutely fascinating to me. I’m very curious to possibly attend it myself. So tell us more about it, how it came about, and what you intend to accomplish, and when and where it will be offered.

Russell:            Okay, well thank you for asking. I set the course up in 2004. I’ve taken it four times a year since 2004, so I’m glad some of it is finally rubbing off on the slow learner, but clearly I’ve picked up on some of the lessons and let’s hope I continue to do so.

The good news is we’re bringing it across the Atlantic for the first time in a very long time. The course itself was put together in the early 2000s by asking fund managers with lots of experience what they knew today that they wished they’d known 40 years beforehand. And, based upon the answers, we built this course.

It’s not a chronological history. It’s not a developmental history about financial institutions. It’s basically looking at why equity valuations mean revert – and they have mean reverted pretty consistently – I do understand that people think it’s different this time, but there is some evidence already that they may be mean reverting again.

We’ve got seven teachers for this. It takes two days when we run it in North America, two and a half days when we run it in Europe. So we will be in Toronto on that incredible week.

On the Monday–Tuesday we’ll be teaching in Toronto. On Wednesday there’s a famous value-investing conference at the IFA Business School. And on Thursday there is an AGM for a famous value investor in Toronto called Prem Watsa and the Fairfax group.

So we are trying to make that a bit of a learning jamboree for investors. And, as I say, we don’t come across the Atlantic very often, but we will, albeit north of the border. We also run in London on March 21 to 23. And, for those of you who have a coat and thermal underwear, we will be at Edinburgh from 21 to 23 February.

Erik:     And the dates, again, in Toronto?

Russell:            Toronto, it’s April 8 and 9.

Erik:     April 8 and 9 in Toronto and there is another conference the following day, if you want to get the jam-packed weekend. Russell, where can people find out about this and register if they are interested in attending on April 8 and 9?

Russell:            We have a website where you can get all those dates. And the full teaching schedule to check whether this is something you are genuinely interested in, and discover the price, of course, as well:

Put my name “Russell Napier” and “practical history course” into any good search engine and you’ll find it quickly. My email address is there. Get in touch. It will be great to see you.

Erik:     Well, Russell, I can’t thank you enough for another fantastic interview. We really look forward to having you back on the program again soon. And I hope to get the opportunity to see you in Toronto myself.

We’re going to have to leave it there in the interest of time. Patrick Ceresna and I will be back as MacroVoices continues right here at