What a ‘Get Out Of Jail Free’ card Covid19 is proving to be for governments of developed nations.
The economy was teetering on the brink before the crisis, with growth hard to find outside of a handful of US tech stocks. A decade or more of close to zero interest rates and multiple bouts of money printing failed to resuscitate the patient. Central banks wondered what else they could do.
Then a meat market deep in the People’s Republic spawned the perfect scapegoat. Switch off the economy and nationalise the financial markets! If I can paraphrase John Maynard Keynes – ‘governments can stay irrational longer than the world can remain solvent’.
Let’s look at America’s reaction so far.
The Federal Reserve has cut interest rates to zero, announced $1 trillion a day in repurchase agreements (effectively overnight loans used to raise short term capital) and unlimited QE including $625 billion of bond purchases a week. At this rate it would own two thirds of the treasury market within a year!
Here’s what most people don’t realise when they read about governments issuing treasury bonds. A ‘treasury’ or ‘government bond’ is a claim on future taxation. Every bond that’s issued pays interest, albeit at close to zero and occasionally even negative rates. But the capital has to be repaid at some point from the government’s only source of income – taxation!
What’s happening in America is that the government is nationalising large swathes of the economy and the financial markets, the Fed is providing the money and is hiring Blackrock to carry out the trades. According to gold and silver expert Mike Maloney, if the current rate of government spending continues it would mean a tax bill of over $98,000 for each and every one of America’s 330 million citizens.
Here in Britain the measures announced by Rishi Sunak have already had to be tweaked as High Street banks initially insisted on 100% personal guarantees for Business Interruption Loans even though the state is supposedly underwriting 80% of the capital. Banks have been so predictably slow to implement the scheme that only 1,000 out of almost 300,000 applications had been successful in the first ten days of the programme.
The hardest thing to predict is what this all means in terms of asset prices, deflation and inflation. According to Professor Russell Napier, speaking to Merryn Somerset Webb on the Money Week podcast, we are within six months of flipping from deflation to inflation. For years Napier has been an avowed ‘deflationist’, so it got my attention when he declared ‘this is the last time in my life when I will have to speak about deflation. We are heading for 30-40 years of inflation’.
If he’s right, that means the end of a 40 year bull market in bonds. Napier also bemoans the ‘managerial capitalism’, as opposed to entrepreneurial capitalism, through which companies have deliberately reduced equity and increased debt to trigger bonusses in the C suite. There needs to be a significant increase in equity if ‘proper’ capitalism is to be restored. Investors should target companies with strong cashflows and limited levels of debt. Dividends are also likely to be in short supply so overall stock market returns in the decade to come must be in question.
Russell, who many of you will remember seeing give an illuminating talk at our Wealth Summit back in 2015 (can it really be five years ago already?), left the most chilling part of his briefing until last. You may be aware that, following the costly government bail outs of banks in the wake of the 2008 crisis, the EU created the Bank Resolution Recovery Directive – it is now illegal to bail out a bank in Europe. First, the bank’s equity and bond holders must be wiped out. Then any depositors with more than 80,000 euros in their account must take a hit. Only at that point can governments step in as a saviour of last resort. With the emergency Covid19 measures effectively nationalising so much of the private sector, what if these same rules are extended from banks to other shareholder owned corporations?
It’s a topic brought up by former ECB governor Mario Draghi in an article mentioned by Money Week writer and value investment fund manager Tim Price when I interviewed him for a new series starting this Thursday. Watch out for a link to Money, Me & Covid19 on our Youtube channel, Elite Investor TV.
Until next time