Three Cheers for Financial Repression

Truth told, it’s more like financial liberation.

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By Tom Streithorst

“Financial repression.” It sounds terrifying, right? It smacks of authoritarian bureaucrats sucking the life-blood out of hard-working, innovative makers and doers.

Umm, no. That’s not even close. It’s about bondholders. Economists started using the term in the 1970s when bondholders were losing money because inflation exceeded the interest rate. Gillian Tett of the FT defines financial repression as government manipulation of investors, forcing them into buying “bonds at unfavourable rates, ie below the prevailing level of inflation.” It strikes most financial writers as unfair that “savers” subsidize “investors” when real interest rates go negative.

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These days, it’s market forces more than government policy that push real interest rates below zero. Whether you call it a savings glut or secular stagnation, our collective desire to save far exceeds our collective desire to invest. Savers want safe assets more than borrowers want to invest in productive capacity. Nonetheless, economists still use the term ‘financial repression’ whenever bondholders, for whatever reason, are receiving interest below inflation. Pundits sympathetic to their plight ask, why should the poor bondholder lose money?

Don’t cry for the rentier class. For the past forty years (ever since Federal Reserve Chairman Paul Volcker manufactured a brutal recession in order to eliminate 1970s inflation) economic policymakers have concentrated on ensuring the profitability of the bond market more than just about anything else. They focused their attention on financial stability and low inflation rather than the traditional goal of promoting full employment.

Consequently, the financial sector has quadrupled in size relative to the rest of the economy, the rich absorb most of the benefits of growth, and workers’ real wages have stagnated or even declined. Financialization has made wealthholders richer than ever, but it hasn’t done much for the rest of us. What is good for the bankers has not been good for the economy as a whole.

This shouldn’t surprise us. Imagine a bread company, its revenue stream divided three ways. The baker, who kneads the dough, gets wages. The entrepreneur who owns the company takes the profit. The banker who lent the entrepreneur the money to buy the oven collects interest. When interest payments go down, the worker and the entrepreneur get to keep more of the cash flow. You would think that would be a good thing. And yet, whenever bondholders don’t make as much money as they desire, pundits decry “financial repression”.

This sympathy for bondholders seems misplaced, considering median male real wages are lower today than they were in 1973, that median real income is lower than it was when Jimmy Carter was President, and household income is lower than it was during the last millennium. When the rest of us suffer stagnation, it is just impersonal market forces, not “financial repression.” When bondholders receive less in return for just…owning bonds, it’s government meddling.

Despite its ugly name, financial repression has historically proven benefits. By limiting the advantages of existing wealth, it lessens inequality and increases social mobility. By forcing investors to buy bonds at rates below inflation, financial repression subsidizes investment, which inevitably stimulates growth. Poor nations from Russia to Japan to China have repeatedly used negative real rates to encourage real investment, build infrastructure, and so develop their economies.

Ever since Deng Xioaping liberalized its economy, financial repression has been an essential element in the spectacular growth of China. By forcing wealthholders to accept low interest rates, Chinese banks are able to lend cheaply, permitting massive investment in infrastructure and industry. James White, an iconoclastic Australian expert in the Chinese economy, told me that cheap capital, much more than cheap labour, has been China’s primary comparative advantage in the global economy. It is financial repression that enabled hundreds of millions of Chinese to escape brutal poverty.

Closer to home, financial repression prevailed in the United States during the Golden Age, that happy period from 1945 to 1973 which saw faster and more equitable growth than ever before or since. From 1945 to 1980, inflation generally exceeded the interest rate on treasuries. Bondholders lost money, but corporate profits boomed, and real wages more than doubled. During the Golden Age, bondholders took the hit but everybody else did better than they ever have since. Financial repression sparked spectacular economic growth and made the repayment of war debt essentially painless. Between 1947 and 1980, government “debt held by the public” fell from 120% to 35% of GDP.

Since 1982, bondholders have had a much better run. Buying a 30-year treasury back then, with a 15% coupon, has been one of the great money makers of all time. The long bond bull market shifted vast wealth from workers to the already rich. The economy as a whole has not done so well. Growth in the developed world since 1982 has been miniscule compared to that of the previous Golden Age. Wages have been stagnant, increasing inequality rampant. The bondholders have done brilliantly, the rest of us, not so much. Maybe financial repression is not as terrible as it sounds.

During the Golden Age, policy makers recognized achieving full employment as their primary responsibility. Since 1982, financial stability and low inflation have taken its place. Ever since the Reagan/Thatcher revolution, the interests of the bondholders have trumped everything else. In 1992, Alan Greenspan shattered Bill Clinton’s liberal ambitions by telling him bond vigilantes would shoot down his generous spending plans. Placating the bond market has been good for the rentier class, bad for workers.

It is not just workers who suffer when policy makers concentrate on making rentiers happy. John Maynard Keynes, in his 80-year-old but still utterly relevant Essays in Persuasion, delineates the opposing interests of financiers and entrepreneurs. Financiers, who lend money, want high interest rates, low inflation, tight money. Their greatest fear is to be repaid in depreciated currency. Everybody else, however, including entrepreneurs, prefers low interest rates, moderate inflation, easy money.

Entrepreneurs borrow money from financiers, which they expend on capital goods, intermediate supplies, and wages. They want low interest rates so they can repay those debts more easily. They don’t mind inflation since they expend working capital creating goods in period one before they gain revenues by selling them in period two. Since creating goods and services comes before selling them, moderate inflation is a good thing for entrepreneurs. Of course, inflation, by encouraging expenditure now rather than later, also stimulates demand, which is precisely what our economies need today.

Today governments need not compel rentiers to accept negative real returns. Market forces do that for us. Capital is no longer scarce. Continued low interest rates (despite their current momentary cyclical jump) are the future as capital goods keep getting cheaper and investors continue to demand safe places to store their wealth. When the desire to save exceeds the desire to invest, it seems inevitable that wealthholders will have to pay a premium to safeguard their liquid capital.

Persistently low interest rates demonstrate capital is no longer a scarce resource. Let’s stop pretending it is, allowing weathholders to demand high returns. If interest rates are a dialogue between the past and the future, savings come from the past and investment leads to the future. Financial repression is the secret sauce that makes economies grow and makes us all richer. We need more of it. Probably the easiest way to stimulate financial repression is to raise the inflation target.

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If we want to sell the benefits of financial repression, maybe it needs a new name. Keynes would call it the “Euthanasia of the Rentier”. I rather like the piquant “Fuck the bankers”. It has the advantage of selling something most people want but is probably too profane to use as a technical term. “Financial Liberation” might be the best alternative. Abolishing the domination of the already rich over public policy would unshackle the rest of us.

2018 March 9

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