My Buddy Russell Napier

By Derek On March 1, 2012 Under Post

It is one of the blessings of old friends that you can afford to be stupid with them.”                    Ralph Waldo Emerson

I ran into an old friend today, Russell Napier, famed big picture macro strategist whose award winning book, “Anatomy of the Bear” makes him an expert at identifying market tops and bottoms. A financial historian at heart, Russell often looks for historical patterns to decipher the barrage of confusing and often conflicting data that assaults the senses today. After trading pleasantries and each of us lying about how good the other looked, I asked him, “Right. Russell, tell me. Are you bearish or bullish?” “Bearish,” came the immediate response. I too have been skeptical of the recent rally in equity markets and asked him for his reasons. Here is the conversation we had in front of the elevators this morning where he tells me I know nothing.

Me: Russell, I am really interested to hear your views. I have been very bearish as well.

RN: Yes, but you know nothing. You are only a stockbroker, not a financial historian.

Me: True. So why so bearish?

RN: We seem to be looking at deflation.

Me: Globally?

RN: Of course globally, you twit.

LTRO = Zero Impact on Economy

Didn’t the ECB just do another “trash for cash” program last night, handing out 530 bn euro to 800 something banks? Isn’t that fresh liquidity to the system?

RN: Yes, they did and no it’s not. If we look at the first LTRO just in December, the ECB lent out cheap money to the banks and most of it was just re-deposited back with the ECB. Some of it went into rolling over short term debt but almost none of it was lent out as “new money” to the private sector. And this latest exercise will be the same thing. This shows us the ECB is not creating money through the banking system. And remember, the ECB itself cannot “create” money, the banks do. They aren’t fulfilling that role.

Me: Does this mean European liquidity then is not easing?

RN: Correct. The banks are not expanding their balance sheets. All we are seeing is a giant refinancing exercise for the banks. This may help the smaller and weaker ones from going under and it boosts bank solvency but it is not resulting in more bank lending. According to the numbers I have crunched back in Edinburgh, net new lending from the last 489 bn euro was just 27 bn euro, or just over 5% of total! The banks simply have no intention of lending and the ECB is just pushing on a string.

Me: What about their securities-repurchase program? I thought they were also doing that to stimulate growth in the Eurozone.

RN: They were but they have cut that back massively and are now hoping to change bank behavior indirectly with LTRO and it isn’t working.

Me: I understand 800 banks participated in the LTRO last night. Surely, not all of them are just taking that money and giving it right back to the ECB?

Cliches and a Big Carry Trade

The bigger ones are using this free shot of capital to play the carry trade. They are borrowing three year money at 1% and buying their local sovereign debt which yields 5%. As long as their sovereign doesn’t default…

Me: Money for old rope.

RN: I can always rely on you for broking clichés. So this money isn’t money lent to the private sector for productive purposes and banks continue to reduce their loans to the private sector. They are only funding the state. The credit available to the private sector continues to contract. This makes me think the outlook for equities in Europe is very negative.

Me: Is that it? Avoid European equities?

And the News Gets Worse

No, the news gets worse, my friend.

Me: Do tell.

RN: We are witnessing a huge secular shift in the recycling of emerging market trade surpluses away from US Treasuries. Did you know in December China dumped $32 bn of US
paper to buy Renminbi?

Me: I heard they were selling some.

RN: So what are the implications for the global economy if foreign central banks stop printing their currency and have to buy it back?

Me: Rising US interest rates?

An Insidious Conspiracy?

Maybe, but it’s more insidious than that. There is a great conspiracy afoot and the walls are tumbling down.

Me: Why do you speak so much better than you write, Russell?

RN: I could say the same for you. It isn’t data just from December I am looking at either. The peak in foreign central bank Treasury holdings was August last year. With smaller trade surpluses EM economies have been forced to buy back their currency instead of print it and they have been selling US Treasuries to do it. This is what I call “The Big Reset” and it means the world is rebalancing, if you will. US savers will now have to step up and fund more and more of the US gov’t deficit. These forces are deflationary.

Me: How?

RN: Most sales people would have given up by now, Derek. Are you sure you want to hear more?

Me: (Nodding enthusiastically).

RN: Right. Unlike banks which can print money individual savers cannot. To buy something they have to not buy something else.

Me: Ah, the “crowding out effect.”

RN: Something like that. Look at the capital flight we have started to see in China.

China Will Devalue


Yes, I have been watching that. Everyone thinks the Renminbi will continue to appreciate against the dollar and I think they’re wrong.

RN: Exactly, they are wrong. I am calling for a Chinese devaluation within 18 months followed by the inevitable trade sanctions. The big question is will China continue to defend its exchange rate if it means a monetary policy that is bad for economic growth and full employment? No, it won’t.

Me: So what does it all mean?

RN: Do you get your lines from bad movies? What I am saying, my friend is the rebalancing of global growth is underway and this is being driven by the rapid rise in the price of Chinese labor. China and other EM countries will continue to withdraw from the US Treasury market. But it is an historical fact that the state must be funded. And it will be funded. Less foreign central bank support will bring in a period of deflation and financial repression.

Me: Won’t the US respond by printing more money, more QE?

RN: The history of printing money to fund government, especially pursued in a period when foreign support for the currency and sovereign debt is falling always ends the same way. US savers will be forced into the Treasury market and the printing presses will print money until they run out of trees.

Me: Didn’t Jimmy Rogers say that about the trees?

RN: I said it first. Governments will come up with new ways to steal your money because they will be funded. You are going to fund them whether you like it or not. This is very bad
for equities and I am very bearish.

Me: Where should one put their money?

RN: You should take it out of countries where the government will take it. I like Singapore dollars.

Me: Wow.

RN: Listen, I’ve got to run and market to real clients who pay real money for this analysis.

Me: Well, it’s been, uh, real. Thanks again Russell.

He lumbers off into the distance clutching his bag, muttering.


Derek Hillen, CAIA

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1 Comment Add yours

  1. horny
    March 4, 2012
    12:34 am #comment-1

    Great post!

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