A new financial policy initiative known by the label “Financial Repression” may soon become our worst nightmare. ‘Repression’ rhymes with ‘depression’ which could be what we have to look forward to as rampant price inflation and permanently lower living standards take hold. Get ready to be conscripted into a citizen army assembled for the greater cause of saving the nation from being swamped by a tsunami of debt. Let me explain.
What is Financial Repression?
Financial Repression is a policy cocktail comprised of large doses of monetary inflation, commonly known as money creation far in excess of the growth in the economy, coupled with interest rates that are below the real rate of inflation. While that may not sound particularly scary, the policy is designed to cause asset and price inflation which is reflective of, and caused by, a devaluing dollar. A much lower standard of living is the inevitable outcome.
What’s the Purpose of Financial Repression?
The purpose of Financial Repression is to allow the US federal government to cope with its overwhelming accumulated debt and unfunded promises for future Social Security, Medicare, Medicaid and employee pensions. It also prevents a proud nation from having to ‘restructure’ its debt as run-of-the-mill dead beat nations periodically are forced to do. Insolvency is just plain un-American for the world’s largest economy, the only remaining super power and the owner of the world’s reserve currency. To declare the equivalent of a private sector bankruptcy is just not in the cards.
In order to make Financial Repression work, the FED needs to keep a cap on nominal interest rates preferably at four percentage points below the real rate of price inflation. Aside from the highly negative impact of decimating the nest eggs of citizen-savers, it has the beneficial effect of inflating away debilitating, pesky and otherwise unmanageable financial obligations of the federal government.
Will Financial Repression Work?
A four percent interest rate below the real rate of inflation, compounded over ten years, reduces in half the ‘real’ value of payments to the government’s debt holders and entitlement recipients. Imagine what it does to the purchasing power of social security payments. Everyone gets the number of dollars promised, but they just don’t buy as much. Magical, isn’t it, especially if citizens think they are getting richer because their pay checks rise and their houses start to increase in price, thanks to inflation.
In the absence of large foreign buyers of US government debt, we the citizens will be conscripted to fill the gap, all for the greater good of the nation’s future. A captive audience of citizen-savers and investors are expected to be a compliant army of civic minded patriots herded into the role of federal bond buyers in order to save the nation for future generations of Americans. Of course we will be assisted by the FED with a rejuvenated and renamed QE3 program...designed to drive dollar devaluation and inflation.
How Will Financial Repression Work?
So how will this new and improved effort at national financial rejuvenation and restoration scheme work? A fixed percentage of all pools of capital - including savings, investments, pension and retirement funds of individuals and institutions - will be mandated to own Treasury bonds as a part of their savings and investment portfolios.
Will Financial Repression Be Voluntary?
As with all conscriptions involving a national crisis, this one will be anything but voluntary. Your personal 401k and IRA are likely to be conscripted to become part of this greater good. Bank assets, insurance company investments, university and other public institution endowments, pension funds and virtually all pools of money will be forced to join the cause of the greater good for America’s future.
How Can Financial Repression Be Avoided?
You could decide now to place some of your money in more friendly investments than US federal government bonds. Bill Gross, head of the nation’s largest bond fund, took exactly this decision a few months ago by unloading all of Pimco’s US government bonds. However, it is entirely probable that Pimco will find itself owning US Treasury paper once again.
If you decide to transfer some of your cash outside the country you should do it soon simply because ‘Capital Controls’ restricting the movement of money outside the US are likely to become increasingly problematic. Rules are already in place to restrict money laundering derived from illicit drugs or the movement of money which facilitates terrorism. Expect more restrictions under the guise of fighting drugs and terror when, in fact, it is designed to ensure there is a large and captive market for increasingly unmarketable Treasury debt.
When Will Financial Repression Begin?
When does this process get underway? As soon as possible, but given the inclination of politicians to present purely positive pictures prior to elections, one could reasonably conclude that it will not be implemented, or talked about publicly, until after the November 2012 election. Political leadership on this issue will remain invisible until electoral risk subsides or until there is absolutely no alternative to a rapidly burgeoning debt crisis.
What Will Cause Financial Repression to Commence?
Financial Repression will be imposed upon us when normal market demand for the massively growing quantities of US Treasury debt dries up. China, the biggest foreign customer for US government bonds, is developing a bad case of cold feet when it considers US Treasury bond ‘investments’. Instead they are mopping up the world’s natural resources from their pot of surplus dollars derived from burgeoning manufactured exports. The Japanese now need to cash in their Treasury debt to pay for tsunami damage, essentially dropping them to bit player status in the bond market. The Saudis and other mid-east oil Sheikdoms need their US petrodollars to buy protection and to insulate themselves from the unsettling consequences of the ‘Arab Spring.’
Why Financial Repression is Coming – to YOU
If foreign buyers with the deepest pockets are deserting the regular Treasury auction of bonds, notes and bills, who is available to pick up the slack? The existing official debt is $14.3 Trillion and the current year fiscal deficit is projected to add another $1.7 Trillion. Since much of the ‘old’ debt continues to mature, it too must find new purchasers.
These troubling realities leave US domestic buyers to do the heavy lifting of buying US government debt. Who might these US domestic buyers be? Think FED and its $100 Billion of magical digital dollars per month, or $600 Billion in total, over the past six months under the guise of Quantitative Easing, commonly known as QE2. While difficult to confirm, it would appear that the FED has bought approximately 70 percent of the debt during this period. What about the period immediately ahead now that the FED says it will stop the QE2 program?
Why Financial Repression is Unavoidable
US sovereign debt is VERY serious. It currently stands at $14 Trillion - the allowable ceiling. Moreover, the federal government is presently running an annual deficit of $1.7 Trillion with deficits of similar dimensions projected into future years. As such, Congress is now playing political games for voter consumption which will lead inevitably to raising this debt head room by a further $2 Trillion, thereby allowing current politicians to get re-elected in November 2012. Given the fact that 42 cents of every dollar spent by the federal government is borrowed money, not tax dollars, the debt ceiling is going to have to be lifted, year after year, by Billions of additional dollars.
That is not the worst of it, however. Projected future deficits are even more overwhelming in that promises to citizens for Social Security, Medicare, Medicaid and other obligations for other services are mind numbing in scale. The worst part is that these promises are dramatically underfunded. Depending on whose numbers are used, what assumptions are made about future economic growth, inflation, rates of interest and similar considerations, unfunded future liabilities range from $60 Trillion to over $100 Trillion. Obviously, growth of the economy and massive tax increases are totally incapable of meeting the debt challenge.
What Can We Expect to Unfold in Years to Come?
Citizen taxpayers and benefit recipients should expect more and higher deficits forcing an ever growing mountain of debt. Current fifty year low interest rates are guaranteed to rise which will make servicing the humongous debt an insurmountable challenge. So what is going to happen?
The U.S. could declare “Banana Republic” style insolvency and embark upon debt restructuring, but that would be the ‘easy’ route out of the debt morass. The US is the world’s largest economy, the only remaining super power and owns the world’s reserve currency. Alpha nations like the US don’t declare the public sector equivalent of a private bankruptcy.
Instead, the US and other first world economies that are reaching similar zombie debt status, will adopt brutally tough austerity measures starting with painful reductions in social security and health care benefits. Tax increases should be expected too, as well as ever more digital dollar printing.
The end result of Financial Repression will be rampant price inflation and permanently lower living standards. Get ready to be conscripted into a citizen army assembled for the greater cause of saving the nation from being swamped by a tsunami of debt.
