Russell Napier
So, there’s two subjects. The first one is a huge subject: the dollar as a reserve currency, absolutely huge. But you made the distinction which people need to think about more, and they don’t, and it confuses the issue, which is: Saudi Arabia may transact with China in renminbi, but will it hold them? There is an upside for the Chinese in just merely transacting in it, because it’s beyond the long arm of America. The Chinese like it if the transaction takes place, but will Saudi hold it? Well, the evidence we have to date; there are two pieces of evidence that I look at. One is the composition of foreign exchange reserves, which we get every quarter. There’s no evidence that the renminbi is being held in reserve currency; it’s held by only one central bank in large size, and that is Russia. Otherwise, it’s tiny, it’s absolutely tiny. And, from memory, I think it was in 2014 that the Chinese first opened up their bond market to reserve managers, and the renminbi couldn’t really form part of reserves until there was a big, liquid market for you to put it into; and that was the Chinese bond market. And since then, virtually nothing has happened.

So, we have to say, look, the ability of reserve managers to own this thing has been around for a long time, the amount of trade they do with China has been going up and they still don’t hold it. Has something fundamentally changed in the world that would make them hold it? Well, if you’re an enemy of the American bloc and perhaps with the interference with Russia’s reserve assets, maybe. But the evidence shows renminbi holdings going down. That is because Mr. Putin is having to sell some of his reserves. So transactions, yes, but ownership, no; and it’s ownership that counts; it is ownership that absolutely counts for the US dollar. The thing that makes the US dollar strong is not that we transact in it, it’s that we own it as reserve managers, and in the private sector.

Then we have some data on the private sector. China, like other countries, publishes a net international investment position. And they reveal in there, as every country does, the value of domestic portfolio assets held by foreigners and also nonliquid assets. That is, the willingness of the foreign private sector to own RMB-denominated assets. That’s coming down; it’s not going up. It rushed up over six years as we included Chinese bonds in the various global bond indices. But now it’s coming down. So at least for the last couple of years – and things can change – the evidence is not that people want to hold more renminbi but that they want to hold less. Now, which currency have we worked out that they want to hold more of over the last few years? Probably the one they want to pay a higher price for. And what’s the one they want to pay a higher price for? It’s actually the dollar.

This could be a long answer, because it’s a huge subject; but let’s go back to Switzerland. In the period after World War Two, if you wanted to seek to avoid the process of stealing money from old people slowly, you put your money in Switzerland. Some of that was to do with secrecy, but actually a lot of it was to do with the fact that Switzerland could be trusted to uphold the rule of law. The country didn’t have a lot of debt, so it didn’t need to inflate away debt. So there were two things here: the sanctity of contract and a government balance sheet which did not require the alleviation of inflation. Is that true in Switzerland today? Switzerland has just intervened and completely overruled private-sector contract law, and the government has a contingent liability, not yet triggered, that is a couple of times bigger than GDP, given Switzerland’s role in the banking system. We can debate the extent of the guarantees in Switzerland, but I think they are pretty extreme.

So, where do you go with your money? I think more of it goes to America. Then we have this incredible speech by Christine Lagarde two weeks ago [i.e. April 17, 2023], which everybody needs to read; it is just incredible. As with most of her speeches, it’s hard to believe that she used to be a lawyer, actually, because she speaks with such imprecision these days that she must have sat at the feet of Alan Greenspan. But the speech, vague though it is, raises these huge questions but obviously focuses on the role of central bankers in a world dividing into two systems. I think what is in there is really a concern about the euro as a reserve currency – it is the second reserve currency.

And if we become one block, and I think it will be by far the biggest and most dominant block, and coagulate more around the dollar, maybe we get more hoarding of dollars and fewer holders of euros; that’s one of the things her speech provoked in my mind. As you say, the decline of these things happens over a long time. There is a wonderful book by Katherine Schenk, called The Decline of Sterling, which I’m just looking at on my shelf. The decline from starting as reserve currency took a long time. Even after the country was bankrupt in 1945, it still took a long time for this to happen. So, I’m not in the dedollarization camp, but I can see there’ll be some bad headlines coming up, particularly in relation to Saudi Arabia.

There could be days, weeks and months where de-dollarization has an effect on the dollar exchange rate, but I don’t think that’s the world we’re living in, and I’m in the other camp. That’s only a partial answer to the first question, but that would be my pushback on de-dollarization.

In terms of the second question, it’s really not whether there’s going to be a recession, it’s what sort of recession it’s going to be.

Genuinely, as a young investor in 1989 and all the way up until the early 2000s, I didn’t conceive and nobody conceived that the threat of deflation could come in a recession. It was thought to be – I heard the word impossible used, in a fiat currency system. Then we had a series of recessions where we had deflation, or the risk of it; and it came with massive defaults, massive write-downs in bank assets, significant write-downs in corporate assets; and suddenly we had an entirely different type of business cycle. It was a business cycle where corporate earnings regularly halved.

That was with the addition of a fair amount of accountancy in terms of swinging impaired assets or cheaper assets through the P&L. But I think what we’re looking at now is a return to those 1945-to-1990 recessions, because as we saw in 2020, credit continues to flow through the recession.

That’s fundamentally the difference between a recession that can become a depression and, if you like, an ordinary recession. These interventions in the banking system are absolutely key. Look at First Republic. As far as we’re aware, people are still paying interest and principal on their loans from First Republic, but First Republic badly priced their assets and that’s been the issue. But they’re not impaired assets; unemployment isn’t going up.

Outside of California, we’re not looking at a collapse in residential property prices, and yet the government is in instantly to back these banks and instantly to keep credit flowing; and, for what it’s worth, the data over the last few weeks shows that bank credit growth is still expanding. In that world, it’s a different form of recession. It’s one that comes with not a collapse in corporate earnings; it’s one that comes with higher inflation. In my opinion, it’s that form of recession, given what’s already happened to the decline in the price of equity since the third or fourth quarter of 2021.

That’s why the market is going up; it’s beginning to realize that this is a recession where we are socializing risk, where we are taking more risk onto the public balance sheet, and that’s good for private-sector assets. So yes, it’s a recession; but we have to remember why we constantly talk about recessions. It’s not the recession that counts, it’s what happens to corporate earnings that counts; and let’s recognize that not all recessions are the same. We all suffer from availability bias, and availability bias in most people is the last recession, and maybe the recession before that. That availability bias makes it so that if you think of the word recession, you think of bank collapse, property price collapse, credit being pulled back, deflation – and of course that’s a possibility.

I could be wrong; but it seems likely to me, given the scale of intervention in the system – fiscal but also monetary – that with governments backing the system, we return to recessions that are more like the 1945-to-1990 ones. By the way, the average decline in EPS in those recessions was 11% – that’s right, 11%. Quite a big range, obviously, but an average of 11%. I would say that this market, by last September, had discounted that form of decline in corporate earnings.

The reason that it’s completely different is because of accountants’ ability and willingness to swing write-offs through the P&L. I think that will happen; and if only for that, the earnings decline in this recession will be more muted than in the past. So yeah, there’s a recession coming, but I don’t think there’s a huge earnings collapse coming. Therefore, as we discussed earlier, some equities are doing really well in this politicized system. But equities, generally, are better than bonds in this environment.