Russell Napier: Inflation, Deflation And Mean Reversion [Slides]

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Inflation, Deflation And Mean Reversion by Russell Napier from the Ben Graham Centre Conference

  • Key to mean reversion of CAPE- changing inflationary expectations
  • CAPE and Q drive capital creation and are reflexive
  • Technology is key but it is never as positive for non-inflationary growth as it seems
  • Deflation or inflation rising through 4% will reduce valuations
  • Equities can adjust more rapidly than bonds
  • Deflation comes next and sharply lower equity prices

Deflation in the age of QE

  • ‘Inflation is always and everywhere a monetary phenomenon’- Friedman
  • We do not live in a fiat system as so many countries manage/fix their currencies to others
  • For EM’s external surpluses dictate monetary policy
  • In fiat systems money is created by commercial banks and not by central banks
  • Demographic trends mitigate against credit and money creation by central banks

Smaller US deficits and EM deflation

  • For almost two decades a widening US current account deficit was the basis for Bretton Woods II
  • Earned surpluses allowed liquidity creation and stable exchange rates in EMs
  • Since 2009, EMs have borrowed surpluses they did not earn
  • The round trip of capital creates liquidity in EMs
  • A country with insufficient surplus and liquidity can deflate or devalue and China is particularly vulnerable

The shrinkage in the deficit is structural

  • The shale oil and gas revolution means fewer US dollars in the hands of foreigners
  • Chinese manufacturing wages have risen 3x since end-2007 in US$ terms, US hourly wages just 12%
  • The baby-boom generation is degearing and saving; and this means less consumption and fewer imports
  • If the US is to run structurally smaller deficits. then Bretton Woods II is unfit for purpose
  • EMs will deflate or devalue; either will bring a global deflation


  • The size of the US current account deficit is a key driver of global liquidity but it is not growing
  • Structural reasons – shale oil and gas, rising Chinese wages, baby boom degearing – stop the deficit growing
  • The de-gearing of the baby boom generation restricts the effectiveness of monetary policy
  • EMs, particularly in Eastern Europe, have borrowed too much in foreign currency.
  • Six years after the launch of QE we get deflation anyway and a move to government action

See full PDF below.

Russell Napier’s speech

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