Financial Repression: Back to the Future (some interesting thoughts, all quotes from the book) Mauldin, John; Tepper, Jonathan (2013-10-23). Code Red: How to Protect Your Savings From the Coming Crisis (Kindle Location 1784). Wiley. Kindle Edition. Today, the Federal Reserve is unofficially keeping interest rates very low so the government can fund itself. There is no explicit agreement with the U.S. Treasury as there was in World War II, but exactly the same is happening in practice. In 2013, for example, the Fed will be purchasing the equivalent of all newly issued Treasury debt through June. The government doesn’t even have to worry about borrowing money. In the words of Governor Richard Fisher, the Fed “runs the risk of being viewed as an accomplice to Congress’s fiscal nonfeasance.” Unfortunately, keeping interest rates artificially low via financial repression has all sorts of intended and unintended side effects that hurt you as a saver and investor. We are sure central bankers would like us to use a prettier -sounding word than repression, but if you are the victim of lower rates, it sounds just right. Of course, if you get a lower mortgage rate or reduced payments, then your view can change. But part of the very act of the repression itself entails a group of people meeting a few times a year to decide who wins and loses. Pardon our cynicism if we find that it is almost always the banks that win. The book to read on the sovereign debt crisis is Carmen Reinhart and Kenneth Rogoff’s This Time Is Different. It is an invaluable aid to understanding how large-scale crises happen and what the inevitable consequences are. Their research showed that high debt harmed economic growth. After analyzing inflation and debt levels for dozens of countries, Reinhart and her colleagues found that most governments don’t get rid of their debt by default. History reveals that they slowly reduce it via financial repression instead: Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression.” Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally ) a tighter connection between government and banks. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/ GDP ratios from the late 1940s to the 1970s. Low nominal interests rates help reduce debt-servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). For the Much like the period of financial repression right after World War II, the 1970s was also a decade of financial repression. In fact , it was during those years that investors started calling government bonds “certificates of confiscation.” When the term became popular, bonds were probably the most despised investments you could find. While the coupon on the bonds was high, inflation was always higher. Bonds were a guaranteed money loser if you were an investor. Today, inflation on government bonds is not as high as in the late 1970s, but the confiscation theme is truer now than ever. Just as in the early 1950s and the late 1970s, if you buy a government bond today, you are being repressed (that’s a technical term for screwed). In her writings, Reinhart lays out the mechanics of how governments quietly steal the wealth of savers and reduce their government debt. The key elements of financial repression are (1) capping of interest rates, particularly those on government debts; (2) forcing insurance companies, banks, and pension funds to buy government bonds; and (3) exerting government control over banks and Social Security funds. The primary way central banks keep yields low is by buying up as many Treasury bonds as they can as part of their quantitative easing (QE) programs. Governments love financial repression for obvious political reasons. When they try to reduce the debt by raising taxes, people are up in arms. Income and sales taxes are visible and explicit. But a financial repression tax that is driven up by inflation is indirect and opaque. However, if governments cut spending to reduce debt, different political groups might protest. But financial repression cuts the debt in many cases much more effectively than either raising taxes or cutting government spending. For governments, inflation is their friend. The government and central banks contribute to higher inflation by pretending inflation is always under control. Until July 1988, inflation forecasts used the implicit deflator of the gross national product, but then the Fed switched to the Consumer Price Index. In February 2000, the Fed replaced CPI with the personal consumption expenditures (PCE) deflator. Thus from July 2004 onward , inflation forecasts have employed the core PCE deflator that excludes food and energy prices. Using lower and lower, less comprehensive estimates for inflation has allowed the Fed to pretend that it is meeting its mandate— but by ignoring high inflation readings. In the meantime, interest rates have been kept too low, and the inflation rate has consistently remained above the Federal Funds rate. Official statistics show that inflation in the United States is low; however, the average person feels inflation is rising quickly. For example, since 2002 the Big Mac has risen in price at nearly three times the rate of overall inflation. People notice that gas prices are also much higher . It is hard to argue with people who point out that prices and the cost of living are going up faster than government-reported inflation reflects. We can all see prices rising. Food, energy, tuition (try managing all that for 30 years with seven kids as John has!)— they’re all going up. John Williams of ShadowStats is the most noted proponent of the position that inflation is running well above the current U.S. government’s number of 2 percent (for the 12 months ending February 2013). Employing the methodology that was used in 1980 under the Carter administration , inflation would currently be about 9.6 percent (see Figure 4.4 ). Using the government methodology from 1990, inflation today turns out to be a little under 6 percent. If the government benefits from stealth taxes, then who is the loser? Economists have a saying, “There are no free lunches.” In a world of financial repression, the biggest losers are savers and older people who rely on savings. Low rates punish savers, leaving them with less money to spend, and that financial hit hurts retirees’ final consumer demand—or that is the view from the cheap seats where we sit. Inflation erodes their buying power over time. A 2 percent negative real rate means the buying power of a currency drops in half in 36 years. Does that seem like a long time? Try retiring at 60 at today’s interest rates and watch as your buying power slowly erodes as you get older. It is down close to 25 percent in just 10 years. But your taxes and fixed expenses will have gone up! Economists can argue that the trade-off is positive, but it seems to us that governments are defrauding a generation or two of hard -working savers. You did what you were supposed to do, and your reward is a 10-year bond at close to 2 to 3 percent or less, depending on the country. Since you paid off your mortgage a long time ago, the lower rates don’t help you either! So you either cut back on your “lifestyle” or move out the risk curve. While better yields can be had with some serious research and homework, it is not easy. The Fed is not going to change its policy to help retirees and pension funds, so older people are left to fend for themselves. Mauldin, John; Tepper, Jonathan (2013-10-23). Code Red: How to Protect Your Savings From the Coming Crisis (Kindle Locations 2049-2053). Wiley. Kindle Edition.
Posted on: Mon, 20 Jan 2014 21:48:59 +0000