• Government loan guarantees mean new money is quickly getting into the real economy
  • Extending and refinancing debt will ultimately result in inflation

Russell Napier, founder of research portal ERIC, has spent the past two decades anticipating deflation. Now, he is predicting inflation will top four percent this year.

What changed? The government has figured out how to create money without utilizing central banks.  

“We’ve spent 10 years trying to create money and failing abysmally, but now we’ve succeeded,” said Napier on a recent episode of MacroVoices. “We succeeded through a thing called the ‘bank credit guarantee scheme.’ It’s working beautifully well.”

The “guarantee scheme,” also known as a government loan guarantee, is the government’s promise to cover bad debts. Commercial banks get the interest (albeit it’s minimal) or, worst case, the government covers the losses. It’s a surefire way to ensure that the banks lend. 

“When a government mandates a commercial banking system to make loans – and it makes that mandate because it guarantees the principal – then it is in the business of creating money,” said Napier. “Most of the money in the world is created by commercial banks, not central banks.” 

This has created a surge in the supply of money, and most of it rests within the small corporate sector. The pandemic makes it harder for people to spend money, particularly on services, Napier said, so the new money is diverted into stocks and other assets. 

“The money is there, and it’s in the hands of people who didn’t have it before,” said Napier. “Crucially, it is not in the hands of savings institutions, which is what happened to the form of money that was created during quantitative easing.” 

Unlike with the Federal Reserve’s bond buying, guaranteed lending gets money into the real economy quickly. All this means that people end up with more debt, but Napier argued that the political incentive to refinance the debt is great enough for the trend to continue. 

“This is a contingent liability on the government’s balance sheet, so it’s not on the government’s balance sheet,” said Napier during a recent interview on The Grant Williams Podcast. “My view is that when it comes home to roost, they might have to put in a couple of billion into the banks to compensate them for loss of principal, they’ll certainly roll over the loans, so everybody can pay back their principal and interest. This is the way we’ve been running banks for a generation.” 

New lending programs will be created, Napier said, and the debt will just get refinanced. But the get-out-of-debt-free-card isn’t really free. The price tag? Inflation. 

Napier points to Spain’s government loan guarantee policy, which targeted small to medium-sized businesses impacted by coronavirus lockdowns. What originally started as a 100-day credit guarantee extended to a 150-day program.

“Just like the wave of a magic wand,” said Napier. 

Emergency lending programs are being implemented all over the world, especially in Europe, and they keep getting extended. That’s the problem, Napier said. One pulse of credit and money into the system would be fine, but it’s not just one pulse. 

“This is the magic money tree,” said Napier. “I keep drawing attention to the longer term consequences of that which are inflation, but frankly, as a politician, when you weigh all those things up, they’re massively outweighed by the positives.”

  • Blockworks
    Reporter
    Casey Wagner covers digital assets and macro economics. Prior to joining Blockworks she was a markets reporter at Bloomberg.