Financial Repression

"You're from Receiving, aren't you?"
--Brantley Foster (The Secret of My Success)

Carmen Reinhart (of This Time is Different fame) writes one of the more cogent pieces to appear on op-ed pages that I can recall. What separates this piece from typical op-ed drivel is linking assertions to tests of truth, using logic and/or empirical evidence.

Reinhart discusses the onset of policies being deployed by governments and central banks that help liquidate debt burdens and ease debt service. She terms these policies 'financial repression' because they are essentially taxes on bondholders and savers.

Financial repression is the consequence of massive buildup in debt around the globe. Reinhart's Fig 1 shows that central govt debt among developed nations is at its highest peacetime level ever--nearly 100% of GDP. Factor in private sector debt and unfunded liabilities and the degree of leverage is much higher.

The important thing to note is that the spike higher to record debt levels came in response to problems caused by already high debt levels. The credit crisis of 2007-2008 was 'fixed' by adding more debt to the system. This, of course, is classic Ponzi--both unsustainable and unstable.

Reinhart observes that large debt:GDP ratios have been reduced throughout history via some combination of: economic growth, austerity (spending cutbacks), debt default, inflation, and financial repression. She also notes that the last two options are only viable for debts denominated in domestic currency. Indeed, for those countries that do have control over their own printing press, inflation and financial repression have been the preferred avenues for coping with the debt overhangs since 2008.

A focal point of financial repression is central bank intervention that keeps nominal interest rates lower than market. All else equal, this reduces government interest expense and leads to deficit reduction. However, when central bank intervention results in negative real interest rates (as is now the case), then this action amounts to a transfer of wealth from creditors to debtors--in the present case from savers to governments.

As Reinhart notes, this is a tax that is largely invisible and discriminatory, thus it is likely to be politically palatable to policymakers and to the masses.

Reinhart also touches on the growing practice of 'monetizing debt,' although she does not term it that. Her Fig 2 indicates that sovereign (and GSE) debt is increasingly owned by government entities rather than by 'outside' market players. This "means markets for government bonds are increasingly populated by nonmarket players, calling into question the information content of bond prices relative to their underlying risk profile--a common feature of financially repressed systems."

Nice point. Financial repression also amounts to distortion of information. Market truths morph into...false signals that have a propaganda feel to them.

Not only do savers have their capital robbed from them during financial repression, but information that might help those people regain their footing is taken from them as well.

Reinhart think financial repression will be with us a long time. My sense is that the time period may last only until the chaos unleashed by financial repression drives systemic collapse.