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I saw their starved lips in the gloam

With horrid warning gaped wide

And I awoke and found me here

On the cold hill’s side.

                                                            John Keats

Commentary & Analysis

Financial Repression: A game every government loves to play

I’ve been trudging through Prof. Michael Pettis’ latest book, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy.  I think it’s excellent.  I’ve learned a lot.  I particularly like his coverage of financial repression.  It is a game all our governments are now playing to the detriment of their own peeps.  Shocking, I know.  J I think and understanding of financial repression may shed some light on why central banks have wondered off into monetary Wonderland, a place where our boy Ben Bernanke stars as The Mad Hatter.  

 “I’m investigating things that begin with the letter M.”

The Mad Hatter

“Financial repression is not always well understood, but in fact it can often be, and usually is, the most powerful of all the policies or conditions that generate trade imbalances and is at the heart of Chinese and Asian overall imbalances. Financial repression matters to trade even more than undervalued currencies, although, unfortunately, it rarely enters into the debate on trade imbalances.

“What is a financially repressed system, and why does it matter? In a recent article Carmen M. Reinhart, Jacob F. Kierkegaard, and M. Belen Sbrancia described a financially repressed system this way:

Financial repression occurs when governments implement policies to channel to themselves funds that in a deregulated market environment would go elsewhere. Policies include direct lending to government by captive domestic audiences (such as pension funds or domestic banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks, either explicitly through public ownership of some of the banks or through heavy ‘moral suasion.’

Financial repression is also sometimes associated with relatively high reserve requirements (or liquidity requirements), securities transaction taxes, prohibition of gold purchases, or the placement of significant amounts of government that that is nonmarketable. In the current policy discussion, financial repression issues come under the broad umbrella of ‘macro prudential regulation,’ which refers to government efforts to ensure the health of an entire financial system.

“As the passage implies, most savings in financially repressed countries, like most of the countries that followed the Asian development model, are in the form of bank deposits. The banks, furthermore, are controlled by the monetary authorities that determine the direction of credit, socialize the risk, and set interest rates. Financial repression is a way of describing a system in which the rates of return and the direction of investment of domestic savings are not determined by market conditions and individual preferences but rather are heavily controlled and directed by financial or political authorities. At the extreme the financial system is often little more than a fiscal agent of the government.”

Key points:

In short, financial repression is a direct transfer from the household sector (who is the primary source for deposits) to the net borrowers, which Prof. Pettis defines as “local and central governments, infrastructure investors, corporations and manufacturers, and real estate developers,” because the repressed deposit rates effectively lowers the cost of capital for the benefitting entities. 

[Note: There was some excitement recently over the fact China was lifting its cap on rates its banks can charge borrowers; but the most telling part may have been caps were not lifted on depositors, steeping the yield curve in favor of banks.  China over the recent past has clearly been the most aggressive of financially repressive government.  Since the credit crunch, however, Western governments have dramatically improved their game.] 

Here are some of my random thoughts on this process and its implications:

  • It’s a reverse Robin Hood when you think about it.  Those that can borrow get the subsidized goodies.  Yet our government is here to “help us” don’t you know.  It really is the big money scam and why the big players in the financial community love The Mad Hatter, i.e. Mr. Bernanke. 
  • It tends to reduce consumer income and therefore consumption.  Effectively this is another way of attempting to increase the relative size of export component, i.e. improve the trade balance and by virtue the current account. Put another way, it forces the major players to scramble for relatively scant aggregate global demand in the world. 
  • It explains why retail investors’ “stretch for yield” and are willing to buy stocks with little regard to risk. 
  • It explains why the big money guys have been so confident stocks can only go higher, and have reaped a huge bounty from their bet.  Liquidity is the mother’s milk of stock prices. 
  • It explains why the real economy, where Joe Six Pack works and lives, is so badly disconnected with the financial economy, where Joe Hedge Fund and his banking buddies work and live. 
  • It explains why big interest lobbyists are flush with cash to manipulate the so-called “Representative Republic,” with a blatancy we have witnessed in our lifetimes. 
  • It helps explain why our government is so dramatically cracking down on US citizens who have money offshore, as those Swiss bankers know all too well. 
  • It may lend credence to the idea if things do get worse, the government may begin to put restrictions on citizens buying gold.
  • It definitely explains why even the US banking system reserves have soared something like 2,145.6% percent since the credit crunch and continue to rise–incredibly.  

(Billions of $’s in banking reserves: Aug ’09 $97.3 billion – Jul ’13 $2,185.0 billion or agrowth of 2,145.6%)

  • It may explain why the emerging market problems may be “their” problems, as the result is likely more developed world investor money returning to the collective coffers of our illustrious governments via those conduits we call banks and Treasury paper.  

I could continue on with this, and I am sure you can add a few of your own, but you do get the point I hope.  Financial repression allows for greater government control over the system is the bottom line.  This is not to suggest all implications of financial repression are negative.  There are times when imbalances are so great government must do all it can to right the system, lest the entire credit system evaporate; some believe that’s the justification for the severe financial repression now being applied in the United States. 

Maybe or maybe not, only the Mad Hatter knows for sure.