Daily Commentary: On Financial Repression
A hedge fund friend of sent a link around to a bunch of us about financial repression. We had an interesting conversation, parts of which I want to pass on to you as my daily commentary. The article was by Financial repression fast becoming a reality by Tony Jackson in the FT. Jackson writes:
The concept of financial repression has been on the edge of investors’ minds for a while. It ought to move to the centre, for it is becoming a reality.
In essence, the process involves governments using their muscle to force down the real value of their debt. It can take many forms, but they boil down to two.
First, governments push down real interest rates, with or without the help of rising inflation. Second, they oblige domestic institutions such as banks or pension funds to soak up government debt at those lower rates.
To see this starting to happen, consider the UK – not because it is unique, but because it illustrates both parts of the phenomenon. Take interest rates first.
At present 10-year UK gilts yield 2.4 per cent, some way below retail price inflation of 3.9 per cent. It is always possible that inflation will fall. But it is worth recalling that the average UK rate over the past decade has been over 3 per cent.
Negative real interest rates are an important feature of repression. While it is not strictly essential for rates to be negative – they need only be lower than a country’s growth rate – it speeds the process along.
I think Jackson puts this well. Now a friend on this thread of the MMT persuasion wrote, saying:
If the Saudis were to flood the market with oil (as the major monopoly producer), and the price goes down, does this count as "repression" of the oil price?
The central bank is the monopoly supplier of the currency. It can set term rates at whatever it wants. I don’t see why this is viewed as "repression". When you are the monopoly supplier of a currency, there is nothing "repressive" about it. The people who use this term are rentiers who think "the market" can and should dictate rates and that he is owed a decent yield for the privilege of holding something yielding more than basic cash.
I agree that the central bank is the monopoly supplier of base money and it can set term rates as it sees fit. However, if it sets rates at a level that is still well below where rates would be if determined in the market place in the third year of an economic expansion, you should feel comfortable calling that repression. Moreover, I would call the Saudis repressing oil prices artificially too in the example above. My response was:
It is financial repression when the Fed tries to artificially suppress rates. It is and will continue to lead to a misallocation of resources and other unintended consequences like shifts into commodities which tax lower income workers. It’s bad policy. I should point out that pensioners are a major loser in this game. Where social security has stopped poverty for seniors, financial repression is bringing it back. There are millions of people just like my mom that find themselves living off of 2% CDs and ask themselves how they are going to make ends meet. They either eat into their savings or reach for yield.
I believe the rate of interest would be higher without the central planning of the Fed setting it low. To me that says projects and companies that depend on low cost or high risk funding are being given a second life they should not have as portfolios are reallocated. And this will misallocate resources and lead to a bust down the line. As for people like my mother, 5 and 10 years later, they are going to be poorer because of all of this.
But unfortunately, financial repression is here to stay.
That’s it. Here are the links.
P.S. Also see Chart of the Day: UK National Debt 1922 to Present. This is what it could look like for the US.
The concept of financial repression has been on the edge of investors’ minds for a while. It ought to move to the centre, for it is becoming a reality. In essence, the process involves governments using their muscle to force down the real value of their debt. It can take many forms, but they boil down to two.
I see no evidence that last year’s SPR release accomplished anything, and would not expect the outcome of another release this year to be very different. A far more sensible proposal would be to build the pipelines necessary to allow the oil currently in private stockpiles in the central U.S. to flow to refiners on the Gulf of Mexico.
As Winston Churchill pointed out, history is written by the victors. The big end of finance, having won decisively in the global financial crisis, is in the process of rewriting history to suit its liking. The cover story in the current Atlantic by Roger Lowenstein on Ben Bernanke, titled simply, "The Hero," is a classic example of this type of revisionist history.
Did Bernanke do it just because he is a corrupt scumbag who wanted to help Financial industry ? Or as it is often stated, he is just an academic socialist with ossified brain who doesn’t know better than to use the Keyneysian “medicine” (a.k.a. “money printing”) ?
It wouldn’t be interesting thing to watch just as well as a lesson to the Ron Paul’s followers (as well as an experiment) to see his policies implemented to the letter – everything. Abolishing the FED, re-introducing gold standard, abolishing the income tax, healthcare, welfare, all the institutions he wants to abolish, all the labour-protection laws, privatizing what little the government still owns (such as selling the National parks)…
My take on Bernanke is that he was/is in a situation where he evaluated the situation politically and the way the system in the US is set-up (consumption-driven) and falling the real income, he didn’t see other option but keep the interest rates low.
When you open a website like the Mises institute (and many others) you will learn that Roosevelt was the most horrible person bound to cut the freedom of the US citizens, and not only he did nothing to end (or at least to assuage) The Great Depression – on contrary – he made it much worse and in fact he prolonged it.
Oldrich, why would you 1-star this post when I presented both sides of the argument? You can disagree with the points but that doesn’t mean it doesn’t make for a good discussion of what policy should be.
I believe the biggest problem with the MMT framework is that the major proponents tend to downplay hidden costs and unintended consequences. That said I think the shift into commodities has much more to do with financialization than low interest rates. The reason being that commodities offer no current income (ignoring lease rates which aren’t available to individual investors), and portfolios held by those people who rely on current income are typically mandated to hold such assets, particularly in pensions or other retirement accounts. And let’s say cash-like assets (in terms of liquidity and safety) did offer a higher return because Bernanke allowed interest rates to rise. This would conceivably lead to higher dollar amounts of spending from people who hold these assets, which would in all likelihood cause the price level of basic things to rise. Real consumption would still be limited to the resources available and therefore not change anyone’s living standards all that much. On the other hand, raising the cost of borrowing in a nascent housing recovery during a period of stagnant income and high unemployment could prove to be a disaster.
Rob,
I agree with you there. There are downsides to every economic framework in terms of its explanatory power. I also agree that the financialization of commodities really has a lot to do with commodity price speculation but I do believe that peak oil is still a valid concern nonethless. Moreover, it is clear that funds have moved into alternative investments as yields have come down because the opportunity cost has diminished since fixed income assets yield nothing. This is one reason gold has done well. When the cost of holding a non-interest bearing asset compares favorably to the opportunity cost of giving up fixed income returns, people are going to shift portfolio preferences and that is what we have seen. This I believe is the INTENDED consequence becuase the shift into higher risk favors asset prices generally then. But all assets benefit from this shift including commodities.
As you say, however, monetary authorities are in a real bind because they want (and need) house prices to remain elevated for longer. I think financial repression will last for years because it is a solution used to avoid the consequences of writing debt down and that means the workout will be protracted.