Financial Repression

 Financial repression is a term and concept that holds practically no familiarity with most Americans. The theory (financial repression) was developed in the 1970s and was initially used to describe bad policies that held back the economies in less developed nations. Although originally associated with countries often referred to as "Banana Republics," we are likely entering an era where U.S. economic policymakers could very well implement financial repression. If this transpires, it will be to the long-term detriment of our economy and the prosperity of most American citizens will be adversely affected.

The national debt for the United States now stands at a staggering $35 trillion, which translates to around $100,000 per person. While the sheer amount is disconcerting in itself, the truly scary statistic is the percentage of Gross Domestic Product (GDP) - 123%. This number was as low as 77% a mere 15 years ago. In historical terms, a high level of government debt as measured as a percentage of GDP can be lowered by one or more of the following:                                                                                                A.) Government austerity programs                                                                                                             B.) Above-average economic growth for an extended period                                                                     C.) High inflation                                                                                                                                     D.) Increased financial repression                                                                                                               E.) Restructuring of debt involving a partial default                                                                       

 If I were a betting man, the bulk of my wager would be placed on "D" above, with some of the bet sprinkled on "C," simply because financial repression offers the path of least resistance for the government to reduce debt.

In a nutshell, financial repression is a gutless, sneaky strategy for the government to channel funds from the private sector to itself to facilitate debt reduction. The government steals growth from the economy with subtle tools like zero interest rates and inflationary policies to knock down its debts. This action results in savers earning rates less than the rate of inflation and is therefore repressive. Other measures include such tactics as caps on interest rates, regulation of capital movement between countries, a tighter association between government and banks, restrictions on entry to the financial industry, and directing credit to certain industries. A couple more direct methods of implementing financial repression would be outlawing the ownership of gold and requiring banks to hold a significantly larger amount of government debt than is necessary for prudential purposes. It wouldn't surprise me to see any of these possibilities come to fruition. 

In a free market economy, capital market interest rates are decided purely by the markets themselves, whereas at times of financial repression, long-term interest rates (bond yields) are kept artificially low by additional demand. The source of this demand and the subsequent buyer of an onslaught of Treasury securities is the Federal Reserve Bank. In addition, in this type of environment, commercial banks and large insurers are also aggressive buyers and holders of government debt. Lastly, issuing debt directly to retail investors, if large in scale and with the specific purpose of lowering yields, also amounts to financial repression. Direct debt sales to retail investors suck out funds from bank accounts. Rather than being intermediated to the private sector, these funds will finance government borrowing. The crowding out of private-sector investment will lead to lower growth and inflation. Ultimately, a lower accumulation of capital will result in limitations to the supply side of the economy. When there is a rise in demand, this will lead to higher inflation.

There is historical precedence for financial repression in the United States as a solution to reducing the public debt burden. Following the Second World War, the Federal Reserve pegged interest rates on government debt at a low level until 1951. Thereafter, the Fed kept interest rates below the level of inflation for several years. While the combined borrowing during the Great Financial Crisis (2008-2009) and the Covid-19 pandemic (2020-2021) probably is responsible for over one-third of our national debt, we cannot continue to spend money at the federal level at amounts we have witnessed over the past couple of years. We simply are no longer in a financial situation where we can do everything for everybody.

One pronounced side effect of financial repression is that it enhances wealth disparity and increases social inequality between segments of the general population. People with financial assets benefit under a regime of financial repression while those without tend to suffer. Those with modest savings accounts earning less than the rate of inflation are penalized. Meanwhile, holders of equities are rewarded. The great majority of modest-income savers do not have the financial resources to take on equity exposure to a significant degree. Whether intended or not, the minority with equity investments are disproportionately benefiting from the constant monetary stimulations that have flooded liquidity into the system over the past 15 years.