'Financial repression' benefits governments but hurts people

Das Capital: Higher tax rates will be accompanied by subtler measures

Satyajit Das
Friday 24 July 2015 23:31
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With policy options limited, governments are increasingly resorting to financial repression. Introduced in 1973 by economists Edward Shaw and Ronald McKinnon, the term refers to measures implemented by governments to channel savings and funds to finance the public sector, lower its borrowing costs and liquidate debt.

Measures include new taxes and increases in existing taxes, in combination with reductions in the level of state benefits or public services provided.

Higher tax rates will be accompanied by subtler measures. Co-payment schemes for government services, means testing, user-pays surcharges and special levies are already evident. “New old” taxes – such as wealth taxes and death duties – will be considered. Entitlement liabilities, such as retirement benefits, will be managed by increasing the allowable minimum retirement age, reducing benefit levels, linking to actual contribution by individuals over their working life, and eliminating inflation indexation. Many of these policies will be packaged as socially and ethically progressive initiatives, belying the financial imperatives.

Policy makers will maintain low nominal and negative real rates of interest, engineering large changes in interest income and expense, with major implications for the distribution of wealth.

In a 2013 study, the McKinsey Global Institute found that between 2007 and 2012, interest rate and quantitative easing (QE) policies resulted in a net transfer to governments in the United States, Britain and the eurozone of $1.6 trillion (£1.03 trillion), through reduced debt-service costs and increased central bank profits. The losses were borne by households, pension funds, insurers and foreign investors. Households in these countries together lost $630bn in net interest income, with the major losses being borne by older households with significant interest-bearing assets. Non-financial corporations in these countries also benefited by $710bn through lower debt service costs.

Deliberate devaluation of currencies is another tool. At various times in recent years, the US, UK, Europe, Japan, China and Australia have sought to devalue their currencies, increasing the cost of imported products for ordinary people and reducing their purchasing power in foreign currency terms. The benefits of devaluation accrue to exporters, in the form of improved competitiveness and higher earnings. The costs are frequently paid for by the general population.

Governments will also exert control over savings, directing them into government securities.

Currently, banks are large holders of government bonds, in part because of the lack of loan demand. If required, governments can legislate minimum mandatory holdings of government securities for banks, pension funds and insurance companies. New liquidity regulations already require increased holdings of government bonds by banks and insurers.

In a number of countries, the government has seized private savings or pension fund assets. In 2013, under pressure to reduce its budget deficit, Spain drew €5bn (£3.5bn) from the state’s Social Security Reserve Fund, designed to guarantee pension payments in times of hardship. The government also had the fund increase holdings of Spanish government bonds to 97 per cent of its assets.

Increased government intervention in the economy, including direct state ownership, can be expected.

Debt monetisation and the resultant loss of purchasing power effectively represent a tax on holders of money and sovereign debt. They redistribute real resources from savers to borrowers and the issuer of the currency, resulting in diminution of wealth over time. This highlights the reliance on financial repression, explicitly seeking to reduce the value of savings.

Ultimately, the policies being used to manage the crisis punish frugality and thrift, instead rewarding borrowing, profligacy, excess and waste.

Policy makers would do well to reflect on John Maynard Keynes’ observation: “[It] is not sufficient that the state of affairs which we seek to promote should be better than the state of affairs which preceded it; it must be sufficiently better to make up for the evils of the transition.”

Satyajit Das is a former banker and author of ‘Extreme Money’ and ‘Traders, Guns & Money’

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