Technical Analysis

Government-backed loans are the new QE

Deficits are increasingly taking government stimulus away as well, as we saw in the UK U-turn.

What’s left to stimulate? Something of a viral interview with Mark Napier has been doing the rounds this week and the capex boom title of the article doesn’t really do it justice.

What he argues is the governments are increasingly turning to loan guarantees. By backing loans to the private sector, it leaves only contingent liabilities off the government balance sheet but allows them to leveraege massive amounts of money into the economy.

“Within the European Union since February 2020: Out of all the new loans in Germany, 40% are guaranteed by the government. In France, it’s 70% of all new loans, and in Italy it’s over 100%, because they migrate old maturing credit to new, government-guaranteed schemes. Just recently, Germany has come up with a huge new guarantee scheme to cover the effects of the energy crisis.”

The schemes run directly counter to the aim of central banks hiking rates. Higher rates restrain lending growth but government-backed loans spur more borrowing. It’s hitting the gas and the brakes at the same time.

He singles out the UK, eurozone and Japan as particularly bad actors.

Napier believes this will result in a paradigm of higher inflation as governments try to inflate away debt burdens. He also sees a boom in government-backed investment for homeshoring or friendshoring.

A good example might be the CHIPS Act in the US, which provides $52 billion in subsidies and loan guarantees for building semi-conductors in the United States. He believes we’ll see 15 years of government-directed investment.

What he worries is that those investments are misdirected, creating high spending but no lasting benefits.

“When the UK government did this in the 1950s and 60s, they allocated a lot of capital into coal mining, automobile production and the Concorde. It turned out that the UK didn’t have a future in any of those industries, so it was wasted and we ended up with high unemployment… First comes the seemingly benign part, which is driven by a boom in capital investment and high growth in nominal GDP. Many people will like that. Only much later, when we get high inflation and high unemployment, when the scale of misallocated capital manifests itself in a high misery index.”

For now, this is good news, he argues, and that there will be some big winners.

“The great problems we have – energy, climate change, defence, inequality, our dependence on production from China – will all be solved by massive investment.”

It’s an interesting framework and one to keep in mind.

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