US economic collapse ‘a given’

A year after the financial crisis shook the world, US stock markets have recovered in the belief that the American economy is on the mend and the worst of the credit crisis is over.
“There’s great relief around the world, and we’re going to see another significant uptick for US equities,” says Russell Napier, strategist at brokerage CLSA Asia-Pacific Markets.

However, it doesn’t take long for Napier, the author of Anatomy of a Bear: A Study of US financial market History Through Four Bear Markets, to offer a rather more grim — even apocalyptic — prognosis for the US economy. “For the next few years, there’s ample credit in the banking system, but it will all end in tears,” he prophesies.

That’s because, he says bluntly, the “public debt bomb” in the US will explode and push the US government into bankruptcy —  forcing it to impose capital controls “within a decade” to prevent a flight of capital to Asia, where currencies and asset prices will appreciate.

“The story of the US for the next two decades is of warfare between capital and the government,” says Napier. The interests of private capital and the US government have been aligned for two decades, but now they are “diametrically opposed,” he adds.
“Not only will private capital not want to finance government debt, it may want to go short on it. It won’t want to hold currencies in the West, and might prefer currencies in the East: that’s capital flight.”

Bizarrely, Napier points out, “credit in America today is bigger than when the recession began (in 2007). There’s no evidence whatsoever of any deleveraging in America… In fact, America is re-leveraging and it’s about to accelerate.”

Even by the “unbelievably bullish” assessment of the US Congressional Budget Office, US public debt will exceed 100% of GDP by 2019. “Even this grossly underestimates the problem,” says Napier. “It doesn’t account for Freddie Mac and Fannie Mae, doesn’t factor in the unfunded pension liability of the ‘baby boomer’ generation who are coming up for retirement, and assumes that there won’t be any recession for the next 10 years, and that average real GDP growth will be 4.1% for the next decade!”

It’s true that America has in the past financed high levels of public debt —“but it did it by having 80% of all the assets of its banking system in government bonds… If that’s the future for America, it’s not one you want to be involved with.” It’s much more likely, however, that the market will call time on such levels of debt, he reckons.

“The most mispriced financial instrument on the planet today is US government debt and the unwinding of that will be the story of this generation,” says Napier.

The US will witness one more deflationary shock in the next five years, but at that time, US government bond yields will go up, not down, he reasons. “You may think it’s impossible, but it’s happened before —- in the 1930s ——and will happen again… At that time, the assets you want to hold on to are Asian currencies.”

And when large-scale capital flight occurs, the US government will respond with any and every ammunition - even going so far as to impose capital controls within a decade, he says. “Don’t expect the government to play by the rules.”