This article was first posted at GoldMoney
Financial repression
2012-JAN-07
This
phrase has suddenly started appearing in economic
research, and will probably do so more frequently in the
coming months. Its origin is a Bank
for International Settlements working paper co-authored
by Carmen Reinhart and Belen Sbrancia, economists well
enough known to merit attention. So what is it all
about?
Financial repression includes directed lending to
governments by captive funds such as pension and
insurance funds, artificial caps on interest rates,
restrictions on capital flows and a generally tighter
connection between government and banks. Some or all of
these devices have been used in the past to reduce the
level of government debt to GDP, particularly in the two
decades after the Second World War. Many countries
reduced the level of their outstanding debt by a
significant amount over a 10 to 20 year timeframe
through these techniques, assisted by moderate levels of
inflation.
Two of the alternatives to financial repression listed
in the paper are clearly unpalatable: default, and “a
burst of high inflation”. Two further alternatives are
either impractical or politically unattractive: economic
growth, which is slipping away further into the future,
and austerity plans involving years of unpopular
policies with the risk of a deflationary depression. For
these reasons, financial repression seems the default
option to Reinhart and Sbrancia.
Some of its elements are already being implemented.
eurozone bail-outs involve contributions from
government-controlled pension funds. Bank and financial
regulation allocates lower risk weightings to government
debt, giving it a systemic subsidy despite current
events. Interest rates are being held below the rate of
inflation by central banks, lowering the cost of
borrowing for most governments to artificially cheap
levels.
But will it work this time? To do so will require
private individuals to continue with an unquestioning
belief in the soundness of their paper currencies. In
the wake of Bretton Woods, when there was a gold
exchange standard underpinning the dollar, together with
higher levels of national patriotism, the might of the
dollar was never questioned. Instead, we now have a US
dollar-standard with substantial levels of foreign
ownership of government debt and an increasingly
sceptical public. This suggests that financial
repression would probably bring on a currency crisis.
Reinhart and Sbrancia are not recommending financial
repression, but they are right to point out its
attractions to governments in financial difficulties. It
is, in the cliché often used today, a description of the
various means of kicking the can down the road. This is
something governments have been doing for a long time:
it has generally worked in the past, so they are almost
certain to assume it will work again now.
However, economic and financial problems are rapidly
mounting. Today’s situation is very different from the
end of WW2 with all that destructive spending replaced
by people rebuilding for the future, as they did in the
1950s and 1960s. Instead, our systemic and economic
problems are leading to yet more deterioration in
government finances. No amount of financial repression
can fix that.
