Financial Repression Can't Work This Time

Financial Repression is defined by as measures sometimes used by governments to boost their coffers and/or reduce debt. These measures include the deliberate attempt to hold down interest rates to below inflation, representing a tax on savers and a transfer of benefits from lenders to borrowers.

Obviously, this is an insidious way of reducing a nation's debt load and is simply a shift in the debt load from the public to private sector. Like the use of military force its use should certainly be done with great discretion if at all.

The use of military force often uses the ‘just war doctrine’ to determine IF it can be used. Some of the criteria that must be met under the just war doctrine are all other means of putting an end to the evil must have been shown to be impractical or ineffective and the use of arms must not produce evils and disorders graver than the evil to be eliminated. Both of these conditions could be slightly altered and applied to financial repression but we will focus on another just war doctrine criteria, there must be serious prospects of success. We will attempt to determine if there is a reasonable prospect of success of reducing the national debt load through financial repression.

Financial repression work by holding debt service costs low through low-interest rates while increasing inflation in hopes of also increasing tax revenue. This increase in tax revenue should, in theory, allow for easier debt repayment.

Methods to keep interest rates low can be accomplished at the short end of the curve by the central bank holding overnight rates low, or quantitative easing on the long end. These methods can also cause inflation killing two birds with one stone. Unfortunately, for those attempting financial repression increasing inflation perception can lead to the non-central bank participants in the bond market to push yields higher. The government attempts to lower or ‘anchor’ inflation perception by under-reporting inflation. The information on how they under-report inflation could go on for chapters but for the purposes of this post understand that it is done, and if you would like more information search hedonic or substitution inflation adjustments.

The simple test to determine if financial repression is a simple look at the debt to GDP, if the ratio is falling it is working; if it is rising it is not. Financial repression was used successfully after WW2 as shown.

Financial Repression after WW2
Data Source: US Federal Reserve and
The current round of financial repression has not had as much luck as shown.

Financial Repression 2008-2014
Data Source US Federal Reserve and

The severity of the financial repression can be determined by the spread between interest rates and inflation. Using the BLS figures and the benchmark 10 year Treasury would show a spread of 2.18% in from 1947-2008 and -0.95%. This would indicate more severe financial repression in the 50’s but with under-reporting inflation methods used now that were not used in the 50’s it is more likely the repression now is as severe or more so than in the post-war period. The Fed is certainly being more aggressive to achieve the repression including lower fed funds rates and several rounds of QE.

In any event not only has the financial repression not been successful but it has not even prevented the debt to GDP from going in the wrong direction.

There are two things that might allow the recent debt to GDP curve to look more like the post WW2 curve and those are more robust growth or more severe financial repression, but are they possible?

The growth from 1947 to 1953 was about 60% compared to 16% between 2008-2014, but GDP growth is dependent on inflation rates so if the real inflation is under reported the spread would be even more severe. The question that arises is, can we attain the growth of the post-war era? The answer is probably no. The growth in the post-war period was mainly a spoil of war. I believe the US government handled this time in a very fair manner that resulted in prosperous times for many war torn nations but none benefited more than the United States. Pretty much all of the industrial nations were severely hampered or destroyed during the war, save the US. This allowed the US to grow off of the profits of rebuilding the world. There is nothing wrong with the US gaining this advantage but it is an advantage we no longer have. This in addition to what appears to be the resource limitations to further growth make rapid growth in our current economic environment unlikely, at least anywhere near the scale seen during the post-war period.

If rapid growth is not possible could the financial repression just be made more severe to reduce government debt loads? To answer this we must realize that financial repression is nothing more than a transfer from private sector savers to government borrowers, essentially a tax. One of the things that must be considered by a government is the ability of the tax payers to make the tax payments in the first place. If financial repression is going to be ramped up the balance sheet of the private sector also needs to be considered. After the war private debt was around 50% of GDP, during the recent ‘recovery’ private sector debt to GDP has been well over 200% of GDP. Considering the government piece of the GDP pie is significantly larger then it was after the war, when thinking about increasing financial repression tax, trying to get blood from a stone come to mind. Putting a larger tax burden on the private sector would also make growth more difficult to attain.

It should be said that relative to GDP the private sector has been deleveraging in part due to the opportunities afforded by financial repression but this far from the intended goal of reducing the governmental debt load. In addition, this is the opposite of what happened during the successful bout of financial repression and it should be viewed as a bad sign for its effectiveness. For the result of deleveraging in both the private and public sectors please read my original History and Introduction post.

This is not to say that further financial repression will not be attempted, only that it will fail in its objective without a debt jubilee, monetary overhaul, or major damage to the real economy

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