A Little Game Called Financial Repression

The term financial repression is not new, but I have been hearing a lot more analysts bring it up and I think we’ll be seeing more written about it in the coming months, so it's worth mentioning it here for all you smart little monkeys to talk about in your new jobs and impress the bosses.

As gross public debt as a percentage of GDP climbs to new highs, both in advanced economies and the developing markets what’s a government to do? Why increase taxes when you can use another, more efficient method, and people won’t even know what hit them?

Financial repression is a little game played by governments, their buddies in the central bank, and the financial markets. Consistently negative interest rates (rates below the inflation level), resulting in a hidden tax on savers and bondholders, with a little dose of inflation. Gee, thanks!

In the meantime emerging markets are imposing capital controls in order to keep the infectious diseases of advanced economies at bay, while the advanced economies are happy to comply, pleased to keep all their money safe within their borders, so they can have more monopoly money in house.

According to Carmen Reinhart, who has written extensively about financial repression,
emerging market economies are welcoming changes in the regulatory environment that keep financial flows are home. She says “this trend is already well under way”, and boy, have we seen it in Argentina, with new import restrictions and capital controls announced every day. In a funny sort of way, it seems that both emerging markets and developed markets have the same goal: keep the money at home. Reinhart finds it unusual that the advanced and emerging market economies are finding a “common cause in increased restrictions on international financial flows, and the return to more tightly regulated domestic financial environments.” She further states that this is clearly paving the way for DEglobalization ( a return to a home bias in finance) and a re-emergence of more heavily regulated domestic market).

Financial repression reared its ugly head after World War II, when the UK for one was able to cut its debt in half within ten years after the war. It’s a nifty way to try to cut a government’s debt with the help of its citizens, except the citizens have no clue what hit them. So the citizens get to fund the war, and to fun the aftermath of the war.

A little bit of inflation is a key ingredient in the medicine of financial repression. In simple terms, this is how it works: Savers lend money to the government at artificially low rates; inflation sets in; the government pays the savers back with money that is not worth monkey shit; the government laughs all the way to the bank; the saver gets screwed.

Not a bad way to tax the little person on an election year.

 
Virginia Tech 4ever:
2/3 of the nation owns homes, so what they're losing in bond and interest rate savings most are making up for in quality of life and in home interest savings given the historically low interest rates. It's not a zero sum game.

How is it not a zero sum game? Do you really believe fiat money creates wealth?

 

GINIs are at record highs in the US and the income of the rich tends to be driven more by capital than labor. So it's only natural that real yields are going to go down if we don't have higher taxes.

Sorry guys. I may be a libertarian, but I also believe in the financial laws of physics.

Maybe one solution is that we remove the Titles of Nobility Clause in the constition and start handing out "The Coolest" to people who pay over $100 million in income taxes over five years and are willing to be subject to a 50% tax rate.

 
IlliniProgrammer:
GINIs are at record highs in the US and the income of the rich tends to be driven more by capital than labor. So it's only natural that real yields are going to go down if we don't have higher taxes.

Sorry guys. I may be a libertarian, but I also believe in the financial laws of physics.

Maybe one solution is that we remove the Titles of Nobility Clause in the constition and start handing out "The Coolest" to people who pay over $100 million in income taxes over five years and are willing to be subject to a 50% tax rate.

/thread

 
IlliniProgrammer:
GINIs are at record highs in the US and the income of the rich tends to be driven more by capital than labor. So it's only natural that real yields are going to go down if we don't have higher taxes.

Sorry guys. I may be a libertarian, but I also believe in the financial laws of physics.

Maybe one solution is that we remove the Titles of Nobility Clause in the constition and start handing out "The Coolest" to people who pay over $100 million in income taxes over five years and are willing to be subject to a 50% tax rate.

I dont see this correlation between real rates and GINI coefficients that you assert. Real rates = real GDP in the long-term. I havent seen any evidence that GINI coefficients are correlated to real GDP. Some of the highest GINI coefficient countries in the World are located in the emerging World where (even with higher inflation) real rates are way higher then they are in the low GINI coefficient countries like Sweden, Norway, etc. Do you have any actual evidence that lower GINI coefficients and higher taxes actually correlate with higher real growth and higher real interest rates?

 
Best Response

Building on what Virginia Tech said, all this inflation hawkishness misses a couple of key facts that are really important to this type of policy debate. The first is that the average Americans net worth is only about 50K. The second is that for most Americans the vast majority of there savings is in their home. The third is that for most Americans, housing is by far their largest expense and for most that expense is a mortgage rather than rent. Finally, and perhaps most importantly for politicians, almost 20% of Americans are unemployed or underemployed.

Inflation does a lot of things, not all of which are uniformly bad. It does indeed penalize savers who hold cash and/or fixed income investments by lowering real interest rates, sometimes to the point of creating negative real interest rates. However it also increases the nominal value of other asset classes such as commodities, equities, and real estate. It also has the effect of lowering real wages. This is important because wages are extremely sticky, and employers tend to layoff workers rather than cut pay during recessions. Lowering real wages tends to lower unemployment.

So, for the average American who has little cash savings, and who owns a house (therefore effectively fixing his single largest expense) which represents the majority of his net worth (and also a massive bet on future inflation), mild inflation is actually a net positive from a financial perspective. It's also makes it more likely that he will have a job because his labor will be cheaper to employers. Sure milk, eggs and gas will be more expensive, and his salary will be lower in real terms, but his housing (again, his single largest expense) will be cheaper in real terms and he'll be working.

Of course there are also losers in this scenario. Retires on fixed incomes get crushed by inflation. Those who do hold a lot of cash or bonds, and those who have already paid off there mortgages definitely get the shaft. Those who already have jobs certainly don't make out as well as there unemployed friends do, and renters also get screwed by rising rents (their largest expense).

So as you can see, it's not as straight forward as inflation = bad. It's definitely not zero sum, and it definitely depends who you are. However statistically, the average American (low net worth, majority of savings in his home, likely to be only intermittently employed) comes out ahead in mild inflation scenarios.

 

So, ah, what do folks propose as an alternative?

Increased interest rates? Then we have to raise taxes or cut spending to pay the interest. Uhh, most of that spending is military, justice, and entitlements, and cutting entitlements also means cutting FICA taxes that support it, meaning we have to hike income taxes even more.

I'm a libertarian because I believe in the hard wall of reality. Unfortunately, the folks at the top who always complain about taxes and low returns and business-unfriendly environments are also discovering the hard wall of reality: there's nobody left to accrue money off of.

 

What you are describing is just the inflation tax, which is hardly a new phenomenon. First of all inflation has been low (around 2%) in the US and Europe for a long time now. Secondly there is very little evidence that inflation will be surging in the future - it's hard to see how that could happen in an economy that's so depressed. Look at the TIPS spread (spread between inflation-indexed and regular govt bonds) to see what the market expects inflation to be in the next 10 years - around 2%.

Btw pretty much all economists agree that a little inflation is very beneficial, because it makes real-wage cuts possible without nominal wage cuts.

 

I'm surprised this hasn't regressed into the usual WSO discourse...

ron paul ron paul ron paul

what about the free market truths?! government make evil distortions

constitution constitution constitution

the bernank is depressing the free market interest rate truths QE14 treasuries buying fed bank unconstitutional for buddies at the goldmans sachs!

gold gold gold

insert youtube video here ...

 
Relinquis:
I'm surprised this hasn't regressed into the usual WSO discourse...

ron paul ron paul ron paul

what about the free market truths?! government make evil distortions

constitution constitution constitution

the bernank is depressing the free market interest rate truths QE14 treasuries buying fed bank unconstitutional for buddies at the goldmans sachs!

gold gold gold

insert youtube video here ...

That's good stuff. I'm a RP guy and still lmao

 
I dont see this correlation between real rates and GINI coefficients that you assert. Real rates = real GDP in the long-term. I havent seen any evidence that GINI coefficients are correlated to real GDP.
It's the distribution of that GDP, though, Bondarb. At some point, wages have to start going up as quickly as profits, and profits are going to have to share some of their lunch with wages. We're going to see that play out as poor and middle-class laborers have fewer kids, demand fewer goods and services along with higher wages, and wages' share of economic growth increases. Any number that can't go up forever must at some point start going down.

As GINIs increased from their lows in the late 70s, we got about 30 years of abnormal net returns on capital- averaging about 10% after inflation but before taxes. Now that GINIs are higher and can't keep going up, we're not going to see the same returns that we saw while those GINIs were allowed to increase.

We can raise rates, but then we have to raise taxes. Or we can sit through a few years of inflation, let the debt shrink relative to nominal GDP, and THEN raise rates.

Some of the highest GINI coefficient countries in the World are located in the emerging World where (even with higher inflation) real rates are way higher then they are in the low GINI coefficient countries like Sweden, Norway, etc.
I think part of the difference here in the US is that everyone has access to the market while you don't see that quite as much in developing countries. Also, GINIs in the US are high even relative to the economy prior to the new deal.
 

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