«We Are Headed Towards a System of National Capitalism»Market strategist and historian Russell Napier outlines a future in which governments mandate where investors should deploy their capital. The global monetary system that has existed since 1994 is being radically restructured.
When Russell Napier speaks, investors around the world listen closely. The long-standing market strategist – formerly with the Hong Kong brokerage CLSA – and author of the Solid Ground Report was
one of the earliest warning voices of an impending wave of inflation in the summer of 2020. When The Market NZZ spoke with him two years ago,
he predicted a boom in global capital investment.
Napier remains convinced that the global financial system is in the process of fundamental change. «We are talking about nothing less than a collapse of the global monetary system as we have known it for the last three decades», he says.
In an in-depth conversation with The Market NZZ, which has been lightly edited for clarity, Napier explains what this means and how investors should prepare for it.
«Historically, every thirty or forty years monetary systems collapse. The current one, the one we have lived with since 1994, is collapsing in front of our eyes»: Russell Napier.
When we last spoke, you said that governments had found the magic money tree: That by guaranteeing bank loans, they could create money at will, paving the way to financial repression and inflating away their debt. Is that still your view?In the long term, yes. Financial repression and inflating away bloated debt levels will be with us for years, even decades. But I think we’re experiencing a hiatus first. Governments did exactly what I said in 2021. They created money on a massive scale. Their actions, quite predictably, led to inflation. But then they panicked. So they handed the ball back to the central bankers and said do something about this. In my opinion, central banks have done too much, they hit the brakes too hard. Hence my fear that we might be facing a deflation shock in the short term.
You’re saying central banks have tightened too much?Yes. We’ve seen a collapse in the growth of broad money in a magnitude that we hadn’t seen since the 1930s. Now, you might say this doesn’t matter since so much broad money was created between 2020 to 2022, and clearly it hasn’t mattered for the past two years. But now it’s starting to bite. That’s my evidence that they have overtightened.
Both in the US and in Europe, M2 growth has picked up again. Central banks have started cutting rates. Why do you still fear a deflation shock?You’re right, M2 growth has picked up a bit, but it is growing too slowly. It would need to accelerate. The level of M2 growth in relation to the current level of interest rates is just not compatible with what would be needed to sustain economic growth.
Inflation, especially in the US, shows signs of stickiness. Don’t you think another inflationary wave might be in the making?
I can’t reconcile that with the growth rate of broad money. Sure, if we were to suffer a supply shock, then inflation would go up, regardless of what broad money does. But absent that, if broad money is not going up, it suggests that economic activity is going to weaken. I always look at things through a monetary prism. In my view, the next shock is more likely to be deflationary.
Where could that shock come from?You and I could hypothesise about that all day. It could be a spike in French bond yields. It could be China floating its exchange rate, which would cause the yuan to devalue. It could be the yen carry trade unraveling again. And there’s a fourth possibility, which is the unknown unknown. Somebody somewhere gets into trouble, and we’ll see something break in the financial system.
So basically you are saying that we first might experience a deflation shock before we go back to a world of higher inflation?Yes, my longer term view of financial repression remains unchanged. That’s the only way I see that will lead us out of the record high levels of debt. Mind you, I use the term deflation shock, but I’m not sure we’ll see outright deflation. Deflation shocks are bad for the economy, they are ugly for equities, and they are very dangerous for high levels of debt. You don’t make money as an investor by trying to predict deflation shocks, you make money by anticipating the government reaction to deflation shocks. And I am convinced that governments will react swiftly by forcing banks to lend, by suppressing interest rates and by using national savings to invest in things they want.
What are the signs that tell you this is happening?On April 26th, President Emmanuel Macron of France held a speech at the Sorbonne, titled
«Europe – It Can Die». Read it. It’s a sea change. In a telling bit of his speech, Macron says that every year, Europeans send 300 billion euros to the US to fund the American government and American corporations. In other words, he's outlining a concept of national savings, and they should be used for the national good.
Mario Draghi in his report to the EU Commission also outlines all the things that should be done with new money. The British, meanwhile, are talking about mandation, which posits that pension funds in Britain must invest a certain percentage of their funds domestically. That’s what lies ahead. Governments will tell investors how and where to invest their capital.
And that would conform to your definition of financial repression?Yes. I say we are headed towards a system of national capitalism. Interestingly, the term ‹national capitalism› has been used before, by a man who used to live in Zurich for a while: his name was Lenin. In a system of national capitalism, governments direct national savings towards national purposes. And our purposes today are investments, as outlined by Macron or Draghi and also by industrial policy initiatives in the US: Investments in energy infrastructure, in defense, in new productive capacity in order to de-risk from China. If we get into a bad Cold War with China, this will have a high national priority.
Do you expect a continuation of the boom in capital expenditures that you outlined two years ago?Yes, everything is aligning. You may call it industrial policy, friendshoring, or de-risking. It adds up to the same thing: state-directed investment. Again, read the
Macron speech. He says if we don’t learn to build stuff again, Europe can die. Of course, he’s prone to overdramatic statements, but he didn’t say Europe is a bit ill. He said Europe can die. This is a question of life and death. Building military equipment is life and death stuff. It has become an issue of national survival to invest. Governments all over the world find the need to direct investments to purposes they want to achieve.
And because debt levels already are at record highs and markets don’t provide financing at acceptable rates, national savings will have to be tapped and interest rates will have to be suppressed?Exactly. Globally, total debt to GDP today is close to 200%. We’ve never seen that before. France is at 311%, the US at 255%, Japan at 400%. We are talking about at least a decade and a half to get this under control. For Japan and France it will take even longer.
Do you see the possibility that technology, such as AI, will create a productivity boom, lifting real economic growth, which would help our economies to grow out of their debt?There are only five ways out of a debt problem: Austerity, default, high real growth, hyperinflation or financial repression. The best one for all of us would be high real growth. To have that, you need a productivity revolution, we’d need to lift real growth to 3 or 4% per annum. Will AI deliver that? I doubt it. Look at the internet revolution: It has transformed the entire world, but it didn’t boost productivity much. There’s an interesting book by my friend Alasdair Nairn, titled
«Engines that Move Markets». He goes back to the railway boom in the 19th century, and he shows a very consistent pattern: When a new technology appears, it attracts huge amounts of capital. There is physical investment on a massive scale. This inevitably leads to overinvestment, creating bad returns, and then the whole thing collapses. It’s usually in the ruins of the first investment bubble where you can identify the truly productive uses of the new technology. Think of Amazon: Today, it’s a clear winner of the internet age. But from 2000 to 2003, its share price fell by 90%. Will AI be different? I’m not smart enough to work that out. But I doubt it.
You mentioned that you see the world moving towards a system of national capitalism. This would upend everything that most investors today take for granted: free flow of capital, market based bond yields, and the like.Yes. The most important part is the idea that national savings shall be used for national purposes. There will be a big push to repatriate capital, back to Europe and back to Japan, for example. The other part is that we need to understand how much of the current world financial system is based on China and its decision in 1994 to manage its currency against the dollar. After the 1997-98 Asian Financial Crisis, most Asian countries started to do the same thing. The result was an exponential growth in dollar reserves. These were all non-price-sensitive buyers of Treasuries and other US assets. This huge flow of capital has pushed interest rates down and equity prices up. Today, 58.5 trillion dollars worth of American assets are owned by foreigners. Arguably, this system started falling apart in 2014, when global forex reserves peaked. It’s now coming to an end, because it’s not working for China anymore. China has reached the end of the rope, both in terms of its total debt to GDP and also in terms of
the rest of the world not willing to absorb China’s overproduction anymore. Historically, every thirty or forty years monetary systems collapse. The current one, the one we have lived with since 1994, is collapsing in front of our eyes.
What will the new world financial order look like?Let’s deal with China first. China will separate from the rest. They will want to adopt a truly independent monetary policy, a policy that will need to be much looser in order for them to address their domestic economic problems and to inflate away their domestic debt. They would simply say the exchange rate is no longer a target. As a consequence of that, I forecast that their currency will fall. Many observers think China can form a new system with their ‹allies›. But for that to happen, we would need to see the holdings of the renminbi as a reserve asset going up. We get data on that every quarter from the IMF, and it shows that it’s not happening. Beijing may be setting up a system where countries can settle trade in renminbi, but so far, all the evidence we have is that nobody wants to hold renminbi as a reserve asset.
Okay, so you think that China will devalue. What about the financial system for the rest of the world?It has to be a system that permits everybody to inflate away their debt. It has to be a system that allows inflation and a suppression of domestic interest rates through the use of national savings. Which means there will have to be forms of capital controls. In today’s world, where most financial assets are held by institutions, capital controls can take the form of regulation. Think of your government regulator mandating all pension funds to buy a certain amount of government debt or other domestic financial assets. That’s what national capitalism will look like.
That sounds ghastly.It won't necessarily feel bad for the whole population – at least for the first several years. Remember, governments want to channel a lot of capital investment into their economies, while slowly inflating away their debt. This system is terrible for savers, but it won’t feel so bad for blue collar workers. An active equity investor can benefit from the redistribution of wealth from savers to workers and from the older generation to the younger generation. There will be some corporate winners in the new regime.
As an investor, where should one invest now?You shouldn’t own any fixed interest securities. None. Inflating away debt means destroying the purchasing power of fixed income securities. There may be rallies, but fixed income is in a long bear market. Bond bull and bear markets move in about 40 year periods, and now we are into year 3 of the current bear market. You can lose a fortune in real terms over the long term. Therefore: No bonds. Period.
What to buy, then?Gold is up 30% this year already, and I’d still want to own gold. It’s the standout asset. I am talking about nothing less than a breakdown of the global monetary system as we've known it since 1994. When the Bretton Woods system broke down in 1971, gold went from $30 to $850 an ounce. All you know is when you get a structural breakdown in the global monetary system, gold will go up. We haven’t seen that move yet. I have just spent two weeks talking to fund managers, and I can tell you they are not really into gold yet. And, of course, the largest part of your portfolio should be in equities.
Which equities should one own?This is rather tricky. Because if we move into a world where every developed world savings institution has to repatriate assets to buy bonds of their own government, they will need to liquidate the one asset they have all crammed into in the past years: the S&P 500. Over the past years, all the world's institutional investors have crowded into large-cap US equities. If they are mandated to own domestic assets, they would be forced to sell US assets. So you would not want to own the S&P 500.
Because that’s the asset that will be liquidated?Yes. And it starts at a historically high valuation. The S&P 500 is excessively overvalued and overowned by foreigners who may be forced sellers.
What should you own then?Equities that won't be liquidated, because they are not overly represented in the portfolios of institutional investors. The unloved, underowned assets: mid and small caps, as well as value stocks. Also, I’d look out for equities that benefit from the global capex boom. Japan offers many of them. The typical fund manager today has 40% in bonds and 60% in equities, of which more than half is in the S&P 500. They're all crowded into the same assets. In order to do well in the big structural change that I see coming, you have to be radical in your portfolio. No bonds, no S&P 500. Buy equities that no one wants today, and own much more gold. Conventional wisdom will declare the quantities you own of these assets risky while accepting that the assets you own are not particularly risky. This is the position that has always rewarded investors when a major structural change has come along.
A little more than two years ago, there was a lot of talk about a renaissance of value stocks. Then, seemingly out of nowhere, came the AI theme, and investors ploughed back into the Magnificent Seven.
Indeed, Nvidia is up over 200% this year. But look at Mitsubishi Heavy Industries: its share price is up 180% this year. Obviously, Nvidia gets all the big headlines, but underneath the surface some of the big shifts connected to the capex boom cycle are coming through. The shift is masked by the success of the Mag-7.
In a world where countries introduce measures of financial repression, the pressure valve would usually be the exchange rate. Looking forward, which currencies would you want to avoid?This is not an easy question, because you assume that market forces will be allowed to work. But take the yen, for example: My view is that Japanese investors will be cajoled to repatriate capital into Japan for years to come. They will be forced to buy JGBs. So yes, the Japanese may be inflating away their debt, but at least for a number of years, the yen would still go up, because of the repatriation flows. The yen is grossly undervalued to start with. The real problem in my view is the euro. If France has to inflate away its debt and Germany doesn’t, you just wonder how on Earth the whole thing can work. Exchange rates are difficult, because for thirty-odd years we have looked at exchange rates based on market forces. Now we’ll have to look at the direction of capital flows, and those may not be market driven but driven by state mandation.
Let’s assume we were in the year 2029 now. What would make you say that, in hindsight, you were completely wrong with your views?If something happens to significantly elevate the real rate of growth. We have talked about AI, and I have shared my doubts. It could also be something that convinces us that we’ll have super low energy prices forever. Who knows, maybe we can get there with these small nuclear reactors. In a world where energy is effectively free, we could have a boost in real growth. It just seems unlikely, because the world is filling up with old people like me, and we are less productive. Read
«The Great Demographic Reversal» by Charles Goodhart and Manoj Pradhan. It’s the best book on the subject. So yes, I could be completely wrong if we had a productivity revolution. Historically, they have been difficult to accurately predict. But it better be a big one. That's what we all have to hope for.
Russell Napier
Russell Napier is author of the Solid Ground Investment Report und co-founder of the investment research portal
ERIC. He has written macroeconomic strategy papers for institutional investors since 1995. Russell is founder and director of the
Practical History of Financial Markets course at Edinburgh Business School and keeper of the
Library of Mistakes, a library of financial markets history in Edinburgh.
