Unless you’ve been solely focused on the movement of oil and silver, then you’ve probably not missed the bickering in Washington over how to reduce the national debt. Within this argument a new term seems to be catching on: financial repression. What is financial repression?
Two economists, Carmen Reinhart and M. Belen Sbrancia, recently put out a paper for the IMF on this topic (read it here: IMF Paper), and the issue basically centers on where investors can “choose” to invest their money.
For the past thirty years, Western investors have generally assumed they could put their money wherever they wanted, since financial markets were organized following the mantra of globalization and free market capitalism. Consequently, the price of money (interest rates) was set largely by demand. Ms. Reinhart and Ms. Sbrancia point out that this freedom was unusual. In the 1920s, global capital markets were also pretty free, but from the 1940s to the 1980s, Western governments operated capital controls and interest rate caps that restricted financial flows, limiting investor choice.
While some of this was due to regulations put in place following the crash of 1929, most of it was due to fiscal policy. Following WWII, developed economy debt reached around 90% of GDP, which is comparable to today. This meant that the Western governments absolutely needed to find someone to buy their debt. Enter the captive investor. By limiting where people could invest their money (e.g., Americans could only buy US government bonds) Western governments created their own market, and the beauty of this was that the bonds paid a lower yield than inflation. This meant that investors were effectively subsidizing government, which allowed the Western governments to reduce their debt. Ms. Reinhart and Ms. Sbrancia estimate that from 1945 to 1980, this subsidy ran to the tune of 3-4% per year, or 30-40% over a decade. That is what’s known as a substantial “liquidation of debt via negative real interest rates.”
Certainly no one in the US government is talking openly about introducing capital controls or interest rate caps, and western central banks seem quite focused on keeping inflation at bay, but there are rumblings in the investment field that as gridlock continues, the temptation to let inflation outpace bond yields will reappear and be seen as the least of the evils. No less than Bill Gross, of PIMCO fame and manager of the largest bond fund out there, has addressed this by saying, “While the ancient Romans used to shave coins in an attempt to monetize debts, our evolving financial system has used more sophisticated techniques. Bond prices don’t necessarily have to go down for investors to get skunked.”
That’s our conspiracy theory of the day. Next week we will be watching Tuesday’s reports on Housing Starts and Industrial Production; and Thursday’s reports on Jobless Claims and Existing Home Sales.