Russell Napier: An amazing buying opportunity is coming in Europe

This is the full transcript of Merryn Somerset Webb’s interview with financial historian and bear market expert Russell Napier. An edited version of the interview was first published in MoneyWeek issue 598 (20 July 2012).

Merryn Somerset Webb (MSW): You’ve just been away for two weeks.

Russell Napier: One week in America and I’ve also been in London, Paris and Frankfurt talking to fund managers about their perceptions of the world.

MSW: That’s interesting. How wrong are they at the moment?

Russell: This is the least wrong they have ever been because they don’t have any opinions. I’ve been doing this for 18 years and usually fund managers are very convinced about something. They have very strong views on something and you can agree or disagree with them. But I didn’t find any strong views on anything, even in the more opinionated section of the fund management community.

MSW: So for the first time ever, the fund management community is completely flummoxed?

Russell: I would say that is correct. And when we discuss it with them it turns out it is for the fairly simple reason that most of them have got degrees in business of some sort – usually MBAs. And on MBAs they teach you basically two things: supply and demand. You work out supply and you work out demand – it should give you the price. But at the moment, the government doesn’t like the price. So there is a whole new layer in there – policy, central banks, government, whatever you want to call it, and they can’t cope with it. That’s not a criticism, because we can’t deal with it either.

MSW: So fund managers now have to be experts in political behaviour, in central bank mechanisms and so on – all these things they are not really trained in.

Russell: Sociology. We’ve transcended finance – it’s in a whole different area. It’s also a structural change and it’s hard to know where that will settle down. We’ve been in a state where markets have been much more powerful than governments. That’s shifting. But how far to the other extreme do we actually go – where do we end up? And there is no simple answer to that. If you look at the balance between governments and markets: post-World War Two it was all about government and not markets. Things changed back in ‘78. We swing from peaks to troughs – it’s all about how society decides it wants the balance to be between markets and governments. So we are looking at a long swing back the other way.

That said, when equities are cheap you buy them anyway, even if you think the structure has deteriorated along the way.

MSW: Your general view on equities at the moment, I think, is that they are cheap, but as this plays out they might well get a lot cheaper – as what you call “the doomsday machine” kicks in and European governments don’t react fast enough to offset deflationary pressures.

Russell: The only equities that are decidedly cheap are European ones, and that’s exactly the situation. You can create a monetary system which would effectively eradicate all the corporate equity there is. If you force a society that is over-geared to the state, the corporate and personal sector, to deflate, that would reduce asset prices, would reduce wages and would reduce revenues to the extent that you could effectively wipe it out. So the ‘buy’ trigger for the market, is a change in monetary policy that prevents that.

But it seems to me that the change in monetary policy is so inevitable that if you had a ten-year view you could buy now. That said you could still lose a hell of a lot of money before you make some…

MSW: You can buy now if you just want to be in, but if you really wanted to make the proper money you could just wait. And while stocks would of course move 5%-10% even the day after the QE, they will pop a hell of a lot more over the following ten years as they actually reverted to their long term mean valuations, wouldn’t they?

Russell: Yes. So the change in monetary policy to look for will either come through the European Central Bank (ECB) or independent central banks. I think you will get a reasonable amount of warning – certainly with the second one you are going get an awful lot of warning: if we are going for independent central banks it means the end of the euro. If it’s the ECB maybe you won’t get as much warning.

But either way it’s safer to wait. If you bought Greek equities a couple of years ago, they probably looked cheap on ten times earnings. They weren’t, which shows you what the doomsday machine can do to valuations. But a reading of financial history suggests that this monetary policy is completely unsustainable; that no society would ever opt to live with the consequences of this and therefore they won’t.

We don’t know how the change in monetary policy is going to come and when it’s going to come, but it seems to me surely inevitable that it will come. Nothing is absolutely inevitable in our business, but no society can cope with what this means.

MSW: Let’s just say that it isn’t inevitable; let’s just say that it doesn’t happen. Let’s say we end up in a doomsday deflationary environment indefinitely. It’s not really impossible. It’s possible, it’s just unbelievably unpleasant.

Russell: Well the reason I say it’s impossible is because the whole thing is ultimately a political construct. In any democracy will we continue to produce politicians who think this is the way forward? It seems to me very, very unlikely. There are some countries that have done this – Latvia is always the one that comes to mind. It’s a successful deflator. But the history of Argentina and its currency board system makes it pretty clear that ultimately most countries won’t put up with it.

MSW: Can fiscal policy help at all?

Russell: Well we’ve stressed it so far – there’s none left.

MSW: There’s a lot of talk about policies for growth – mostly that means fiscal stimulus. You don’t think that’s possible?

Russell: If the very strong countries who can borrow money at 2% decided to expand, it is an option. Germany could extend its fiscal policy.

MSW: We could borrow at those rates. Would you disapprove of a huge fiscal stimulus programme in the UK?

Russell: I would actually. I’m kind of old fashioned. I would insist that we take some pain and prepare for the next generation. That public debt and GDP is important and we shouldn’t be burdening the next generation with our own public debts.

MSW: More quantitative easing (QE)?

Russell: QE is to keep the money supply growing. It’s not going to do much for the economy at all. The only thing that’s going to do something for the economy is getting the banking system working. They have to aggressively focus on that.

MSW: How?

Russell: When you own a bank it shouldn’t be that difficult to get it to lend. I can see why a Conservative party is cautious on this because it smacks of a command economy banking system. But the banking system is the key.

The [Bank of England’s] Financial Policy Committee has now relaxed the liquidity rules for British banks. So that’s an important step. It’s the banks, the banks and the banks. That’s the secret to getting things moving in this country.

MSW: So we just have to go easy on them for a while?

Russell: As much as it pains everybody. Ultimately they have to be regulated. But we have to ease up a little bit on that at the minute. We need bankers. You can hate bankers and recognise that you need bankers at the same time.

MSW: You can hate a particular kind of banker without hating all bankers surely.

Russell: I think maybe what most people in the street don’t fully understand is how important banks are at creating money and not just credit. And a society where there isn’t enough money about is a society which historically has been a very bad place to live. So we have to accept that we need bankers and in the fullness of time create the sort of bankers we want. But if we do it too quickly it gets in the way of credit.

MSW: What sort of bankers do we want? What’s the perfect banking system? If we start now, where do we hope to end up?

Russell: We’ve never had a perfect British banking system. I do think however it was better the way it was before, with proper branch bank networks and loan decisions being made at branch level.

MSW: And a separation of commercial and investment banking?

Russell: I don’t have a problem with that at all. I think that’s just prudent. Fundamentally the state backs the deposits. So the biggest contingent liability in the state is actually not the baby boom generation (although it’s kind of a close second). The biggest contingent liability in the state is its deposit insurance.

Now if we are going to insure the funding of an organisation you are going to have to do something extreme, like making sure you regulate what it is doing with its assets. And I think the extreme thing is to make sure that there are only certain things that they can do with the assets. That’s the safest form of banking system.

MSW: So they need to be split?

Russell: They do need to be split.

MSW: Absolutely nobody appears to disagree on this point. It seems perfectly clear to you and clear to me. So why isn’t it happening?

Russell: Well we’ve lived in a society where there has been a degree of capture – there is a certain degree of capture by financial services in the political process. I think it is worse in America than it is in the United Kingdom. That capture will end I think with the Libor fixing scandal. It is such a big thing that that will change attitudes. The politicians… well you can see them ditching bankers left right and centre.

MSW: Do you think that the Libor scandal has caught the imagination of the public because the newspapers were able to put the word ‘mortgage’ in the headlines about it? They have manipulated this interest rate which could have affected your mortgage payments! That suddenly made it relevant to everybody.

Russell: Absolutely. I mean it has been esoteric. Nobody who was walking down the street jumps up and says “have you seen this disgraceful thing with CDS?!”. But clearly with this it begins to hit home.

Until now people could see this was a game played amongst professionals to fleece each other, if you like. That’s a fair game; that’s the professionals; that’s what they do. But when they see that this impacts them in such a direct way, it makes it completely different. You might say these were greedy people, but now you might go further and say these are venal people, or corrupt people. Or fraudulent people. This is not a victimless crime anymore.

MSW: So suddenly something has to be done.

Russell: Yes, and you can see the change in political tone very rapidly.

MSW: Did you feel even the tiniest hint of pity for Bob Diamond?

Russell: No. If you live by the sword, you die by the sword.

MSW: Has something gone wrong with capitalism?

Russell: Well, there are lots of elements of it that haven’t worked and you are not doing it any favours if you are not prepared to accept that all systems are not perfect, all systems need repair. This one clearly needs repairing in so many aspects, particularly in long term investment. If we could fix the problem of short-termism and make corporations owned by the owners and not traders, then I think 90% of the other problems would go away.

MSW: So how do we do this in the corporate world? Because we have been writing a lot about the capture at the top of the corporate world; about the way we have shifted away from long-term shareholder capitalism to a very short-term version of shareholder capitalism; and about the damage that that has wrought on everything from income and equality to economic growth as a whole.

It seems almost unfixable. You might be able to change some of the incentives at the top but you can’t change the short-term buyers of the shareholder base. How do you make people buy and hold shares in good companies – and so care about the company’s long-term future – rather than endlessly trade them?

Russell: I have a solution. Stepped dividends.

MSW: So you get a better payout the longer you hold?

Russell: Correct. So let’s say the company declares a dividend. If you’ve held for less than one year you get one-third, if you get to two years you get two-thirds and if you hold for three years you are entitled to your full dividend.

There have to be rewards to make people behave like long-term investors. I like the carrot of dividends, but we will probably end up with the stick of tax

Future returns are likely to be heavily dividend-orientated. Most fund managers are managed against benchmarks so they haven’t a hope in hell of beating the benchmark unless they are committed to picking up some of these dividend cheques. A stepped dividend, which I think would require changing the law, would get us where we need to be.

MSW: Brilliant Russell, that’s brilliant.

Russell: And suddenly we have a solution.

MSW: Why has no one told me about this before?

Russell: I don’t know. It seems perfectly reasonable to me. There are other views of course – perhaps that it could be done with voting rights.

MSW: So no voting rights if you don’t hold for a certain amount of time?

Russell: Yes. But then you would have companies such as News Corporation where the power of the Murdochs would be immense. So I am not so keen on that. There is another one too. I wouldn’t favour it, but it’s the one that’s going to happen anyway – high transaction taxes.

If you think that the long-term return from equities is only 6% in real [inflation-adjusted] terms but it suddenly cost you 1% every time you did a trade, you wouldn’t do it. If you were a professional fund manager trying to beat an index, it would give you an impossible hurdle. So I do think the transaction tax is all but inevitable, even if my dividend method is clearly more pro-market.

MSW: It’s much better. I have written in the past that much as it pains me I almost approve of the transaction tax because at least it does exactly what you just said – creates friction and hence long-termism, but the dividend one is much, much better.

Russell: I started off by saying the same thing. For all its negatives, if a transaction tax achieved long-term investment then we have to put up with it. But I think the dividend one is a better way of doing it.

MSW: Although it might encourage all sorts of slightly strange behaviour if people try and turn dividends into gains somehow. It might encourage even more buyback behaviour – which we disapprove of – and so on.

Russell: Perhaps. But there have to be rewards to make people behave like long-term investors. I like the carrot of dividends, but we will probably end up with the stick of tax, which the French are very keen on.

MSW: And if they do it we have to do it too?

Russell: I don’t know about that. The British government could hold out against anything as long as it is borrowing at this rate. It’s when it can’t borrow at this rate that suddenly it’s thinking about other things.

MSW: And when will that happen?

Russell: I don’t know.

MSW: You’re not allowed to say I don’t know. You’re the guru.

Russell: I don’t know.

MSW: But it will happen?

Russell: It will happen – I’m sure it will happen. As it will happen in the United States. It might even, and I know this is very controversial, but I think it could happen in the US before the United Kingdom because of the Chinese.

MSW: Let’s move onto China.

Russell: The interesting thing here is that the Chinese widened the bands on their exchange rate on 16 April. Since they did that, their currency, the renminbi (RMB), has not hit the top of the exchange rate band [ie it isn’t trying to appreciate]. Now, if they are playing by the rules that means they haven’t bought a single Treasury since 16 April. That’s a big story.

There is no way of knowing whether they are buying or not, as they camouflage it very well – but at least based on the rules they haven’t been buying. But the scary thing would be if their currency hits the bottom end of the band. Then they’d have to sell Treasuries – very publically. They have other assets they could sell [to force the value of their currency back up] but Treasuries are the most likely thing.

MSW: Is that going to happen soon?

Russell: The RMB is slowly weakening. It never weakens enough in a day to hit the bottom end of the band, but it’s drifting lower rather than drifting higher. When currencies move precipitously it’s never the current account, it’s always the capital account. That’s important because there is evidence of very significant capital outflow from China. And further acceleration in that could have the RMB going towards the bottom end of the band fast.

People have borrowed a lot in dollars and used the cash to finance projects in the Chinese currency partly on the basis that they always knew the Chinese currency went up 5% a year against the dollar. What if they wake up one morning and it’s actually going down?

The number from the Bank of International Settlements is that China has borrowed $498bn offshore. Not all of that will be used to finance RMB projects, they may have been financing mines in Africa with it and so on. But a significant portion of it has been – all based on a spreadsheet which said the RMB goes up 5% against the dollar. And now it’s going down.

So taking all that back to the Treasury market, if you wake up one morning and the RMB is at the bottom end of the band, you really could get something quite nasty happening. All the traders will wake up in America and they will know that the biggest owner of Treasuries – and the PBOC [People’s Bank of China] is probably neck and neck with the Fed now in terms of what it owns – is a guaranteed seller. We are looking at a forced seller. And it could go on day after day. Most people still believe that China’s currency is undervalued, when it clearly isn’t. So no one talks about this.

You can make money in China, but it’s a completely different set of skills

MSW: It seems pretty clear cut – why is it that most people persist in thinking the RMB is still undervalued?

Russell: It is really only since they widened the bands on 16 April that it has become apparent. There are a lot of eminent economists who say it’s undervalued. But the best definition of whether something is undervalued or not is what it trades at in the market if no one is interfering with it. I think it is just taking people a while to adjust to it.

But it is also that the consequences could be so dire that nobody really wants to think about it. It’s the stuff of cheap novels: PBOC liquidates Treasuries. It’s inevitable it will happen one day, but as you can’t say when, why would you want to even contemplate what it means today?

People say that the Chinese wouldn’t defend their currency for very long [ie they’d stop selling quite quickly and just let the RMB fall] because the implications for them and the rest of the world wouldn’t be good. But even three weeks of defending the currency would be a huge thing. It could be like October ’87. The Baker Commission – the authoritative work on October ‘87 – to the extent that it blames the crash on anything, it blames it on rising bond yields due to foreign liquidation of US Treasuries. That headline “PBOC sells Treasuries to support RMB” – well who buys that day?

MSW: Wouldn’t the Fed have to buy?

Russell: That would be an interesting conundrum because for the Fed to buy, the Treasury has to expand its balance sheet so it creates dollars. So the PBOC is liquidating the Treasury and the dollar, and the Fed responds by printing more dollars.

MSW: And then you have an inflationary situation?

Russell: Well, that would take some time. The thing is, if it was Argentina we would all have an instantaneous response to this; there would be no doubt whatsoever that this was a bad thing to do. Because it’s America, perceptions are different. The Fed buying these Treasuries, creating money because the PBOC is selling Treasuries and dollars, is the same thing but it’s called the United States of America and not Argentina.

MSW: Now, the capital outflows from China, how does that work? China has quite strict capital controls, so how does money leave?

Russell: Well you need to speak to private bankers because it’s largely illegal, but I can give you some practical examples. Ever since China opened up, it has been done via transfer pricing of goods. So say you and I make tables in China: we set up a company in New York and we export the tables to the company in New York. Now we make sure that the price it goes to New York at, is a price which just covers the cost in China, so no profits would accrue to the Chinese company.

MSW: So all the profits accrue in New York.

Russell: That is a form of transfer pricing which has been underway in China for three decades, so that’s not a new thing, that’s been underway for a while. I don’t think that’s what’s exacerbating this. But it gives you some idea of how easy this is. Private bankers in Hong Kong have got any number of ways of doing this.

Here’s another one. Let’s say I’ve got 100 million RMB on deposit in the Bank of China in Shanghai. I tell the bank I would like to borrow against that in Hong Kong dollars and that I will offer more collateral than usually required. The Hong Kong bank might want deposits in China anyway, so they lend me the money in Hong Kong dollars. I take the money in Hong Kong dollars and disappear.

MSW: There is also lots of talk of the huge amounts of money flowing out through Macau. But I guess the real question is why now?

Russell: I think the fundamental reason is that there is nothing to invest in in China. Let’s say we lived in China and we were accumulating RMB, where the hell would we invest it? Historically the main source for savings was back into the business, but the wage squeeze is very big and it’s probably structural in nature because of the demographics. Also the Chinese government wants to narrow wealth differentials, so that squeeze on your return on equity is going to be prolonged. So you want to do something else.

Usually you would speculate in property. Well, you can’t do that anymore. Deposits always give you negative real returns. And they’ve even been clamping down on the unofficial lending market. So the only logical place to move our money is offshore.

There are other factors. Number two is the political change. Number three is that as savings in the economy go up, you would expect some international diversification – it is perfectly normal. If we go back 30 years, there were no savings in China. So you couldn’t have capital outflow because there was no capital.

So as they accumulate more capital, you could expect bigger and bigger amounts of that to be leaving, which would be natural. The wealthy section of the population want to leave anyway.

MSW: 80% of students who go abroad never go back.

Russell: The Wall Street Journal asked Mandarin speakers in Vancouver why they live there. They gave four reasons. Rule of law, clean air, health care and education. If you are a primary school teacher in Vancouver you get all of those with your taxes. If you are a billionaire in Shanghai you don’t get any of them. So if you create a society where the wealthy wants to move away, then clearly some of that wealth, if not all of it, is going to go with them. You are creating a society which has a problem.

The crucial bit is that for two decades this country ran a current account surplus and a capital account surplus. It’s highly unlikely that we are going forward with this double surplus to infinity. People just assume this is the status quo for China, and it won’t be.

Other reasons. Arbitrage is a good one. If you had said to a Chinese guy 20 years ago, one day you will sell a flat in Shanghai and you will be able to buy three houses in Florida, he would have thought that was insane. Now that is a trade that you can do. That has got to be getting attractive for Chinese people. They never dreamed that they could do it and now they can.

MSW: People keep telling us obviously that Chinese equities are really, really cheap. Really cheap. So cheap that it doesn’t matter about all the things floating around the Chinese economy. It doesn’t matter about a hard landing, soft landing argument. They’re so cheap it doesn’t really matter what happens. But it’s not really so is it?

Russell: I start from a more basic proposition which is: are they companies? And for many of them, the answer is ‘no’, and so therefore there is no valuation for them. I find it difficult to say, “hey is the market cheap, is it expensive”? It’s part of the state and as part of the state I don’t how you can put value on it. Not on the matrix that I’m using. The matrix that I’m using is irrelevant for valuing this thing.

I once had a long dinner with a fund manager in China who had been doing it really since the market started. He was a huge fan of Warren Buffett; I was there with another fund manager and they just talked about Warren Buffett for the whole dinner. So afterwards I said to him: how do you use the skills of Warren Buffett to make money in China? He laughed so much he almost fell off his chair. He said, if we want to know where the stock market is going in China, we ask the government.

MSW: It’s a shame no one told Anthony Bolton that.

Russell: No comment. I’m not saying you can’t make money at it – absolutely not. Of course you can make money at it. But it’s a completely different set of skills.

MSW: Where do you invest your own money, Russell?

Russell: Mine is very conservatively invested in a couple of investment trusts, and it’s pretty obvious to work out which ones they are edited version of the interview. And then after that it’s in cash and a bit in gold. Singapore dollars is a preference. Because of one of my main concerns about this shift between capital and labour, is that capital controls will be introduced at some stage, so I want to have my money somewhere where it remains flexible. I put Singapore pretty much at the top of the list for that.

MSW: So you think Singapore is somewhere you will always be able to move your money in and out of relatively easily?

Russell: Certainly out. There are some countries that will try and stop you getting in. I think that could happen in Germany. I just read Exorbitant Privilege, the Barry Eichengreen book – it goes through the things that Germany was doing in the ‘70s to try and stop people from putting money in.

Here’s a nice easy one which wouldn’t even probably constitute a capital control. Say they brought in a withholding tax of 100% on foreigners’ interest and dividend income. That would have a big effect. Is that technically a capital control? I don’t know legally, but it is actually a tax. The other thing they did in the ‘70s is made banks that took foreigners’ deposits in deutschmarks had a much higher reserve ratio than those that took local deposits.

All these mechanisms are ones that some of the more attractive countries, such as Singapore, Germany and Switzerland, will have to follow. One of the reasons people say that the euro could never end is the damage it would do to Germany. Revaluation of its exchange rate would wipe out its export sector and cause huge losses on bank loans to southern Europe.

But if Germany could implement capital controls that kept the dislocation of the deutschmark to 10%-15% and not 35%-40%, which most people talk about, then Germany’s options for leaving the euro are bad but not as cataclysmic as some people think they are. Angela Merkel’s big assertion is that she has to assert the primacy of politics over markets. Ultimately I don’t see how she can do that without some sort of exchange controls. But anyway, we haven’t got there yet.

MSW: How is that going to play out?

Russell: Well, on the dissolution of the euro, capital controls are kind of guaranteed.

MSW: As soon as Greece leaves the euro you have to bring down capital controls across every border to stop the rest imploding – capital flight from Spain and so on.

Russell: That would be my view and there has also been a leaked story suggesting the same on Reuters.

Politicians are really easy to work out. They wake up every morning with two difficult decisions to make and they make the least difficult decision.

MSW: How would capital controls work if the euro survived?

Russell: Well, it might work the way we just discussed, but not necessarily. The first move may not necessarily be to stop money leaving Spain and Italy but to make it punitive to put it into Germany for foreigners – Germans would call it the anti-speculation tax. It is more difficult to stop money leaving than to try and make it punitive for people to put it in.

So that might be the easy place to start – nibbling away at it before you go to these draconian “no bank transfers out of Spain and Italy”; that maybe comes second, but the euro exchange rate I think does suffer if Germany starts to try and prevent capital coming in.

MSW: OK. So capital controls either way.

Russell: I think either way. One is inevitable and the other is a 50-50 shot I think.

MSW: And from the US?

Russell: Nobody else will ever introduce capital controls until their bond yields are at a level like Spain and Italy. I don’t mean on the absolute level – I mean at a level which questions the solvency of the government. And when you get to that stage everything is on the table, absolutely everything. Because the other options for the government look so bad that they wouldn’t contemplate them: close the government, default on your debt, very high levels of inflation.

So capital controls come right up the agenda. But when you can borrow at 2% or 3% there is absolutely no need. But politicians are really easy to work out. They wake up every morning with two difficult decisions to make and they make the least difficult decision. Restricting the free movement of capital or closing bits of the national health care? It’s a no-brainer.

Now, we’re not there yet because we can borrow at reasonable rates, but if it comes to the time when we can’t borrow at reasonable rates and one of the sacrifices is the free movement of capital, then it is so obviously one of the things that a politician would sacrifice first.

MSW: So if MoneyWeek readers want to be absolutely sure that they can continue to take their foreign holidays into the future, they really should be owning a flexible currency abroad somewhere. Where is safe apart from Singapore?

Russell: My friends in the hedge fund community like Norway. And I don’t think the Swiss would ever stop you taking your money out. But it’s not a long list. The Singapore dollar is also undervalued – it should generally go up. So hopefully you make a small profit too.

MSW: What do you think about investing in the bond markets of other solvent-looking Asian or emerging market economies?

Russell: A year ago I used to think that was a good idea but actually it is complicated. A lot of these emerging markets have borrowed dollars offshore. This is the whole story about emerging markets: they borrow too many dollars. I think they have done it again.

Now people will say that’s irrelevant because their foreign currency reserves are so big. Well yes, but the problem is if you start using your reserves to defend your exchange rate you tighten domestic monetary policy. So India, to the extent that it has made some attempts now to defend its exchange rate, is beginning to tighten monetary policy at a time when its economy may not need a tightening.

So I think that is the story again, despite the huge level of reserves. Look back to China – would China ever use half of its reserves to defend its exchange rate? It’s impossible, because it would contract domestic liquidity, spike up domestic interest rates and create domestic chaos.

So the reserves are kind of a red herring really, because the implications of using them are actually pretty dire for the domestic economy. We’ve seen it over and over again in emerging markets. We’ve seen it in the United Kingdom. We jacked interest rates to 12% to defend our exchange rate for five minutes. We could have absolutely defended the exchange rate with interest rates through monetary policy. But society couldn’t live with 12% base rates, and China is the same. These reserves really are a red herring – they will never be able to use them for anything.

MSW: And gold? You are still holding gold – as insurance.

Russell: I believe in deflation so that’s not good for gold full stop.

MSW: But you believe in deflation followed by inflation right?

Russell: Sure. I personally would call where we are now a deflation shock, although we ultimately haven’t had anything that you would call deflation.

MSW: We are slightly losing the battle now though.

Russell: I think we definitely are. Winning the war ultimately will involve lots more government control of various parts of the economy, particularly the banking system. We fought a battle against deflation in ’98, in 2003 and in 2009, three successful battles. But the damage done to the central bank balance sheets in the West and to the governments’ balance sheets was huge.

We are getting to the end of this. So what do you do next to beat deflation? Get the governments involved in the banking system to get the banks to lend money and create money. If inflation is everywhere and at all times a monetary phenomenon, you are going to have to get the banks on board.

MSW: So you are effectively, if not actively, nationalising the banking industry across the world. You are nationalising its activities – you are directing its activities.

Russell: You are directing its activities. There are better ways to do that and there are worse ways to do it, but one way or another that’s what will happen.

MSW: Can I invite you to give us one piece of good news?

Russell: Equities are a lot cheaper than they were in the year 2000. We’ve been through 12 years of this. Also, I think the fundamental good news for anyone invested in equities is that when they are cheap they can discount just about anything and the bond market can’t. The fixed coupon is a fixed coupon – it cannot change or shift or mutate or adapt, and that’s why bonds are death and equities are life. So opportunities come in equities because they are adaptable; they are run by people and human beings. The other positive thing is that while we have a doomsday machine in southern Europe ultimately people won’t put up with it. So we know that’s going to change…

MSW: … and we know that our amazing buying opportunity is really, really coming and we can start buying in bit by bit now.

Russell: Remember that bit in Catch-22 in the bar. They’ve had the Germans through, they’ve had the Italian fascists through, they’ve had World War One, they’ve had World War Two, and this old Italian guy says that nothing has really changed. Look at an Italian corporation for instance, and at what it has been through in the past hundred years. It’s still there. It still makes money. And now it’s cheap too. This society won’t put up with the doomsday machine. So when it’s gone there is lots of money to be made.

MSW: Thank you.

• edited version of the interview.

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