Russell Napier on a crisis in emerging markets and the private debt overhang

I was looking at fund manager GMO’s quarterly newsletter just now when I was reminded of a recent Russell Napier interview with CNC-TV18 in India in late May.

Now is a time to think of EM as cyclically weak

Before I get into what Napier was saying, let me note that GMO is bullish on emerging markets. And EM has been getting killed, in large part due to the strong US dollar. So it’s always interesting to read how a fund manager messages to clients when the calls they make blow up.

Now, the dollar issue is one that was easy to spot and I flagged it with respect to EM in May in a post on why I’m not an EM bull. What’s more, the Fed has signalled quite strongly that it doesn’t care about emerging markets in making policy. Policy divergence will continue to be an issue until the economic trajectory of the US and the rest of the world start to track one another.

In short, if you want to go long EM, now is perhaps the worst time to do so – late cycle after a huge run-up in shares globally, with the US leading the charge in normalizing rates. And as GMO’s Ben Inker himself put it in the quarterly letter:

Insofar as a country has debt denominated in US dollars or other hard currencies, a falling currency can make debt service costs more onerous, hurting the economy or corporate cash flow directly. This is not a material issue in the developed world, as the vast majority of debt in developed economies is denominated in the local currency. But emerging countries do borrow in foreign currencies.

What’s Russell Napier saying?

So that brings me to Russell Napier. Take a look at this 12-minute video below. (If you don’t see it, here’s the YouTube link)

Notice that right off the bat, he talks about Turkey. As you know, that’s where I am, talking about Turkey as a Thailand-style canary in the coalmine. It’s not that Turkey is the end all and be all of EM debtors. But it is sizable enough that a default would create contagion. That’s Napier’s point.

But even before he gets to the EM part of his analysis, Napier points out that the inflationista argument is flawed, particularly at this point in the economic cycle. It’s based on the Phillips Curve view of tightening labor markets driving inflation higher as workers bid up wages. We haven’t seen any signs that this worldview makes any sense though.

Moreover, Napier points out that all you need to do is look at monetary aggregates to see that debt-fuelled growth is tailing off right now. He says US money supply growth is 3.7% and that this is growth rate in the bottom 16% since World War 2. Napier also sees low money supply growth in India and China as well.

And I would make the Steve Keen point here that credit-fuelled economic growth is dependent on maintaining a growth in credit. The reason that money supply growth is waning is simply because debt stocks are high and rates are going up. Since we are late in the cycle, financial institutions cannot maintain the same level of credit supply growth without taking on undue risk.

Final thoughts

I am going to leave it there for now. Do watch the entire interview because Napier says quite a bit more. I would stress that these things take a while to play out though. And while I am anxious about how this cycle ends, I am still near-term bullish. If you want to make historical comparisons, for me, it’s more 1997 or 1998 than it is 1999 or 2000.

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