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The Rise of National Capitalism
Alan Pentz
December 08, 2024
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Over the last two weeks I’ve talked about the status of each of the major regions of the world now that our geopolitical and economic order is rapidly changing. I followed up talking about how I see the US reorganizing the system. Today I want to talk about one of the themes shaping this transition: national capitalism.
As far as I know the phrase was coined by Russell Napier based on a recent article of his called America, China, and the Death of the International Monetary Non-System in American Affairs and in an appearance on the Hidden Forces podcast. Napier is an economic historian I’ve cited multiple times in this newsletter.
What is National Capitalism?
National capitalism means more active government involvement in the private sector economy to manage towards national goals. It’s being triggered by two main trends. First are the large debts many countries hold as a percentage of GDP. These debts need to be financed and there are signs that the global flows that have funded these debts are beginning to shift. Second is the breakdown in the international economic and trading system or as Napier calls it the non-system.
Both of these trends will incentivize countries to bring capital they have invested abroad back home. As China and the US decouple, China will eventually stop buying US Treasuries. This could lead to a spike in interest rates to attract other capital and a subsequent deflation of economic activity and asset prices as borrowing becomes more expensive.
As I pointed out last week, a former Trump Treasury official, Stephen Miran, has talked about effectively coercing our allies to replace China as a main buyer in exchange for trade and military protection from the US. I expressed my skepticism about that plan and Napier poured more cold water on it.
As the system breaks down almost all our allies will need to bring capital back home to reinvest in their own countries and manage their similarly large debts. They won’t have that much spare capacity to buy US treasuries.
The added issue is that 25-30% of the stock in the S&P 500 index is held by foreigners and their governments. They will be under substantial pressure to repatriate that capital to shore up things at home. As a result, we could risk a large fall in the value of US stocks and bonds in a short period of time as we go through this transition. The US and other governments will have to intervene to stem the worst of these effects.
Financial Repression
National capitalism will be driven by two main mechanisms. The first is financial repression. Financial repression is a series of measures governments can take to inflate away debt to GDP overtime. It usually involves the government requiring entities like banks, pension funds, insurance companies, and other financial institutions to buy its debt at prices below the inflation rate. The Federal Reserve regulates banks and can require them to hold more “safe” capital aka Treasury bonds to pass regulatory tests.
Additionally the Federal Reserve can buy longer dated Treasuries to keep interest rates from spiking. That’s called yield curve control or quantitative easing (QE). The Fed did QE from the beginning of the Great Financial Crisis until inflation spiked two years ago.
As former World Bank Economist, Anne Krueger, wrote in Project Syndicate:
When used in the past, financial repression has worked, reducing the US debt-to-GDP ratio after World War II from 116% in 1945 to 66.2% in 1955 (and further thereafter). Moreover, Carmen M. Reinhart, now the World Bank’s Chief Economist, and Maria Belen Sbrancia of the International Monetary Fund have estimated that between 1946 and 1955, the US liquidated debt amounting to 5.7% of GDP per year through financial repression.
This gradual reduction came about because interest-rate ceilings were lower than the rate of inflation, resulting in a negative real return to creditors during this period. Reinhart and Sbrancia estimate that if real interest rates had been positive, US federal debt in 1955 would have stood at 141.4% of GDP. That 75-point difference reflects the amount by which government debt would have increased had the government not resorted to financial repression, all else being equal.
This process is not without costs. Napier calls financial repression “stealing money from old people slowly.” Older people are savers since they are done working. For financial repression to work it will also require the government to adjust the inflation calculations for Social Security and Medicare so that benefits increase below the true rate of inflation. A key part of this process is doing it slowly. Any sudden loss of purchasing power will cause widespread anger as we saw during the inflation post pandemic.
Industrial Policy
The second element of national capitalism is industrial policy. This involves the government channeling investment into key sectors through a variety of means other than the market.
We’ve already done a lot of direct industrial policy in the US. Congress passed several major pieces of legislation over the last 3-4 years that focused on spurring domestic production much to the dismay of our allies who wanted to compete for the funds. The Inflation Reduction Act, the Bipartisan Infrastructure legislation, and the CHIPS Act used both tax incentives and direct funding to encourage domestic production of semi-conductors, green energy, battery production, etc.
It seems to me that if this is the approach under a Democratic Administration dedicated to strengthening alliances, the approach under a Republican one will hardly be better. Most allies would be forced to repatriate capital to ensure they maintain some industrial capacity with similar legislation of their own.
While the era of large splashy infrastructure bills is over for the time being, the US and other governments will continue to shape policy and incentives to encourage national capitalism through tax, trade (tariffs and currency controls), and regulatory policy.
Taxes
I could see future governments intervening to allocate capital by providing tax credits or accelerated depreciation for targeted areas. We did that with solar, wind, and electric vehicles in the IRA. I see similar policies for a variety of other priorities going forward. In my view traditional tax incentives for business will be increasingly targeted toward key areas and limited for areas out of favor.
For example before 2017, companies could deduct interest expenses on any debt used in the business. Trump’s Tax Cut and Jobs Act limited that deduction to 30% of the a company’s adjusted taxable income. A future tax bill could limit deductibility of interest to favor domestic investments that increase employment or re-shore critical supply chains.
Additionally, I think US multinationals’ days of transferring assets to Ireland to get better offshore tax treatment are numbered. The era of global corporatism is coming to a rapid close. I also wouldn’t want to be running a traditional private equity playbook using debt to buy companies, layoff staff, roll them up, and sell them on to the highest bidder.
Tariffs and Currency Controls
The US in particular can do a lot with tariffs. We import much more than we export so a general rise in tariffs will hurt surplus exporters more than deficit countries like the US. Of course, tariffs will increase the cost of goods for US consumers. This will largely be a one time adjustment as new tariff rates are set rather than an ongoing inflation issue. On the positive side, they will also encourage domestic investment in production which will create new jobs here.
It’s also likely that we will limit the ability of money to come in and out of the country quickly. Countries like China have used the purchase of US financial assets like Treasuries and mortgage bonds to push up the price of the dollar and keep their currency and exports competitive. We will most likely begin to limit their ability to do so.
Regulatory Policy
In addition to requiring financial institutions to buy government debt, it’s likely the government will shift the regulatory apparatus to favor domestic production. This will mean limiting environmental laws and other barriers to permitting new construction for production. We’re already seeing major pressure to increase energy supply because of AI. This will happen across many sectors.
I think we’ll also see efforts to limit offshoring of labor or transfer pricing by American multi-nationals to take advantage of low tax countries.
The Limits of National Capitalism
While these trends seem inevitable to me, the US and its allies will need to cooperate to navigate their way to this new global system. If you are Germany, Japan, or France, it isn’t viable to simply pull all your assets out of the US all at once. These countries depend on the US as a market, for military protection, and those assets are investments. No one wants to sell all at once and realize the losses.
Similarly I believe the US will have to cooperate with allies to build more industrial capacity to replace China. This really hit home reading Noah Smith’s recent post Manufacturing is a War Now.
As you can see China dominates industrial production now with a 45% share. We have no choice but to work with every ally we can find to build everywhere. No single nation can shoulder the burden alone. The United States must lead a process of repatriation of capital, divestment from China, and rebalancing of the system in as orderly a fashion as possible.
It seems to me we will realize this is the only option at some point in the next year or two as the limits of tariffs policies become clear. It might be spiking interest rates or supply shocks of critical goods that bring us to our senses but soon after we will double down on constructing a global coalition to re-industrialize our alliance network.
What’s the Timeline?
Of course as the great investor, Howard Marks, said, “The difference between being ahead of your time and wrong is indistinguishable.” My guess is that if Trump holds true to imposing blanket tariffs, this transition happens in the next 2 years. If, as many speculate, he is threatening tariffs as a bargaining chip, the timeline is longer. Maybe 5 -7 years.
Eventually though it will become clear to the US that continuing to have links with China is feeding our enemy and it will become clear to China that they can’t export their way to sustainable growth. At that point the non-system collapses. We’re seeing the drip, drip, drip but the gusher is coming.
Keep learning,
Alan
P.S.
1 According to Napier, the former Federal Reserve Chair and inflation slayer, Paul Volker, referred to the current order as a non-system meaning that no one would ever sit down and design a system from scratch to work as the current one does. It evolved accidentally.
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