Tuesday, May 10, 2011

Macro Economic Focus: What is Financial Repression and Why Should You Care?

Today I'd like to focus on an important macro economic subject which was the subject of PIMCO's Bill Gross May Newsletter.
The Caine Mutiny (Part 2)
  • Low policy rates and the increasing negative real yields that they engender as inflation accelerates represent an immediate threat to investment portfolios.
  • Bond prices don’t necessarily have to go down for savers to get skunked during a process of “debt liquidation.”
  • PIMCO advocates a renewed vigilance, stressing bond market “safe spread” alternatives available globally, including developing/emerging market debt at higher yields denominated in non-dollar currencies.
That gives you the idea and general overview. For those who want to know more, let's go the March 2011 Carmen M. Reinhart and M. Belen Sbrancia IMF paper which Gross quotes, "THE LIQUIDATION OF GOVERNMENT DEBT."
To deal with the current debt overhang, similar policies to those documented here may re-emerge in the guise of prudential regulation rather than under the politically incorrect label of financial repression. Moreover, the process where debts are being “placed” at below market interest rates in pension funds and other more captive domestic financial institutions is already under way in several countries in Europe. There are many bankrupt (or nearly so) pension plans at the state level in the United States that bear scrutiny (in addition to the substantive unfunded liabilities at the federal level).

(I read "This Time is Different" by Rogoff and Reinhart and reviewed it in depth here, also well worth reviewing.)

In addition, here is a very recent Seeking Alpha article on this same subject: Protecting Against 'Financial Repression' which uses the above book's definition of financial repression:
Banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payment system. Governments force local residents to save in banks by giving them few, if any, other options. They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form oftaxation. Governments frequently can and do make the financial repression tax even larger by maintaining interest rate caps while creating inflation.

Note that this subject of financial repression applies primarily to "savers" and is akin to a form of hidden taxation. Also note that Gross and the Seeking Alpha article make related investment suggestions.

Update: Also see FT Alphaville has a post up on May 13, 2011 titled "Help! We’re all being financially repressed!"

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