What is Behind the New Buzzword
Economists, market analysts, journalists and investors alike are all talking about it quite openly, generally in a calm and reserved tone that suggests that - to borrow a phrase from Bill Gross – it represents the 'new normal'. Something that simply needs to be acknowledged and analyzed in the same way we e.g. analyze the supply/demand balance of the copper market. It is the new buzzword du jour: 'Financial Repression'.
The term certainly sounds ominous, but it is always mentioned in an off-hand manner that seems to say: 'yes, it is bad, but what can you do? We've got to live with it.'
But what does it actually mean? The simplest, most encompassing explanation is this: it describes various insidious and underhanded methods by which the State intends to rob its citizens of their wealth and income over the coming years (and perhaps even decades) above and beyond the already onerous burden of taxation and regulatory costs that is crushing them at present.
It is as though a highway robber were not only content with robbing you at gunpoint on the street, but were emptying your bank account by having his associates hack into it at the same time and then visiting you at home to break into your wall safe for good measure.
One would think that people should be up in arms over it and do everything to avert it instead of merely calmly discussing it with a proverbial shrug.
How and why has it come to this? Why is there this sudden need for the State to not only openly grab the vast bulk of what its citizens produce, but add to the loot by robbing them by thinly disguised stealth methods as well? There are two main reasons for this: the legacy of the past and the unwillingness to shrink the power and size of the State.
Time Preferences and Obstacles to Reform
In democracies (especially when they are using a fiat money system) time preferences tend to be much higher than they would otherwise be. This is most pronounced in the case of the political class: the average politician cares not one whit about the long term health of his nation's capital stock - it doesn't belong to him after all. However, he is in a position to dispose of other peoples' wealth and will almost always do so in a manner that 'buys' the maximum of votes in the next election. Note that this tendency to maximize the income obtained by political instead of economic means raises the time preferences of nearly everyone in society – this is so because it diminishes the prospective return on capital for everyone, including of course those whose wealth is diminished by taxation. Long term economic growth suffers accordingly (for readers who want to know more about this particular topic, Hans-Hermann Hoppe has written extensively about it).
Ever more promises were made to ever more people, ever more privileges were extended and ever more costly welfare and warfare programs were initiated. It was seemingly easy to pay for it all: tax revenues were high and what could not be obtained by means of taxation was simply borrowed and/or printed. It has been perfectly clear for a long time that the funding of all these programs would not be sustainable in the long run. Even the governments own 'watchdogs' like the 'GAO' ('government accountability office') in the US and similar offices elsewhere have continually made a compelling case that spending needs to be reined in.
Alas, in the long term 'we're all dead' as Keynes maintained, so why worry? To the politicians of the day, the long term has always been something someone else would eventually have to deal with.
We have now arrived at the edges of this long dreaded moment, the time when the piper will have to be paid. The moment that could always be put off in the past has clearly been reached in the euro area for instance, where the limitations on government financing imposed on the supra-national central bank have unmasked the truth about government finances in a number of countries.
The past cannot be undone. In many cases it has become impossible to get rid of so-called 'entitlement spending' short of declaring national bankruptcy – it has become part of so-called 'mandatory spending' (we have to use quote marks here because a sufficiently motivated political leadership could deal with it if it wanted to). Moreover, politicians are loath to cut discretionary spending as well: no matter what type of spending is cut, there will be 'blowback' from the vested interests that are denied their place at the trough. Any spending cuts or economic reforms that really make a difference are a sure way to lose elections.
As an example, consider Gerhard Schröder's actually not overly radical welfare state and labor market reforms in Germany. He undertook them in light of the economic pressures German reunification had produced. They went against the grain of what his party (the social democrats) stood for. They most certainly led to his electoral defeat. And yet, today it is widely acknowledged that Germany's economy would have continued to stagnate and could never have become Europe's 'economic locomotive' without them. The positive effects arrived far too late to save Schröder's political career – he actually made policy for the long term, a rare exception.
Leviathan Doesn't Want to Shrink
Apart from the legacy of the past – which consists of the already accumulated outstanding public debt and the many promises to continue spending – there is a desire to keep the State's bloated size intact at all costs. Every single bureaucracy within the State is eager to keep growing and amass more powers over time. No ministry wants to be the one that bears the brunt of prospective spending cuts.
Regular readers know that we have focused our criticism of EU-style 'austerity' on this point: governments that are reluctantly forced to reduce their deficits and debts in the euro area tend to do so in a manner that aims to keep the size of government unaltered – the main focus is on raising taxes even further, not on slimming down the bloated State. The banking industry – which is the industry enjoying the biggest of all privileges, namely the power to create money ex nihilo – is likewise taboo. Apparently there cannot possibly be too many banks or any banks not worth saving at tax payer cost. Meanwhile, the system's ability to obtain profits by denying savers a return on their savings is couched in propaganda about the alleged necessity for central banks to manipulate rates to zero, and in some cases even below zero, to 'save the economy'.
Numerous ways to avoid spending cuts and to diminish the value of outstanding debt have been thought up. This is where financial repression comes in.
It can take many forms – higher taxation, capital controls (either open or disguised), the imposition of negative real interest rates, regulations that force investment into government-desired channels, selective defaults, credit dirigisme, monetary inflation and so forth. We cannot accuse the political and bureaucratic classes of a lack of creativity in these areas. Nor can we accuse them of hiding their desire to impose additional oppressive taxation.
Below is a clip that shows Austria's minister of the interior holding forth in parliament not long ago. Consider in this context that the total tax burden imposed on the country's citizens amounts to 60% at this time (you'll have to use Google translation, the article is in German). It is also a country in which political corruption and waste of tax payer funds have attained what are often stunning proportions (to no detriment to the perpetrators, as the ministry of justice can stop any and all investigations at will). Here is the clip (her rant begins at 0:38)
ustria's interior minister Johanna Miki-Leitner, talking about the need for a new 'solidarity tax'.
Here is a translation of what she said:
“…and when the rip-off artists and speculators among the top income earners are asked to pay up, and they have the feeling that we are ripping them off, then I can only say, they have anyway no sense for the collective good, for our community. Then I simply say to them: Fork over the dough! Fork over the millions! Fork over the loot!”
This by the way is a 'conservative' politician. Consider also that there really are no 'speculators' in Austria. Neither are there many rich people and most of the known 'rip-off artists' are as a rule members and/or friends and relatives of the political class. What they are ripping off are tax payer funds. In fact, Austria's small handful of 'rich' people consists of utter financial midgets compared to e.g. the rich in the US. Under the guise of 'taking from the rich' (who somehow automatically seem to be deserving of opprobrium, because what else can they be if not 'rip-off artists and speculators'), Mrs. Miki-Leitner's rant indicates that taxes will be raised further on everyone. When is it going to be enough? As noted above, the tax burden on the middle class already amounts to 60% of its income if calculated correctly.
We don't want to pick specifically on Austria as it were – it merely serves as an example of the hubris and shamelessness of the modern-day political class when it comes to the forcible appropriation of other peoples' property. It is roughly the same in virtually all of Europe.
Below we bring a few recent examples of 'financial repression' activities on the part of governments that show the many guises which the policy is taking apart from the well-known fact that central banks are inflating all out.
Recent Examples of Financial Repression
One example is the US 'FATCA' Act, a thinly disguised attempt to introduce capital controls through the backdoor by making it nigh impossible for US citizens to hold funds abroad. The reporting and compliance requirements the law imposes on foreign financial institutions are so complex and costly that many of these institutions have simply ceased to do business with US clients. This has created undue hardship for US citizens residing in foreign countries. A recent article at BC Business describes the problems faced by banks and credit unions as well as their clients in Canada as a result of this law. A few highlights follow below. First an example of what it can do to private citizens who try to comply with the regulations:
“New U.S. laws targeting overseas tax cheats have not only left a million Canadians facing the potential of financial ruin, but have put local credit unions in an impossible bind.
Maury Williams, a 68-year-old history professor at UBC’s Okanagan campus, was born in Australia, moved to the U.S. with his family as a child and acquired U.S. citizenship at age 15, when his mother decided to become a U.S. citizen. He moved to Canada in August 1973 to take a teaching position at the now-defunct Notre Dame University in Nelson, and became a Canadian citizen in 1986.
That seemingly benign history has created a nightmare. In May 2011 Williams and his wife Linda realized that their status as U.S. citizens requires them to file U.S. income tax returns. The rule has been in place for several decades, although it is rarely enforced by the U.S. Internal Revenue Service. Wanting to do the right thing, Williams and his wife plunged into the Byzantine world of American tax compliance by entering the Offshore Voluntary Disclosure Program — a program designed to give U.S. tax cheats a chance to come clean without facing criminal charges. He has since discovered that it is not the way to go for anyone whose only transgression was not knowing the U.S. requirement for expatriates to catch up on tax filing.
As of this summer, the adventure has cost the couple $28,000 in accounting fees and nearly $18,000 in back taxes owed to Uncle Sam. And it’s not over. At press time, the Williamses were awaiting a response from the IRS on all the paperwork filed through the Offshore Voluntary Disclosure Program in December 2011 on their “catch-up” with filing requirements. The IRS could assess late-filing penalties that would add tens of thousands more to what they’ve already paid, putting them at risk of financial ruin.
Put aside the cost for a moment, and consider what this has done emotionally, psychologically and physically to this ordinary Canadian family whose only “crime” was that at one time they were U.S. citizens. Asked about the impact, Williams said, “Nightmare, unfairness — it goes further for me. I’m not quite sure how to put this, but my wife has an arthritic condition, and it’s gotten a lot worse. We’re both convinced that the stress associated with this has had some impact. It’s affecting our health. Linda and I have gotten to the point where we don’t talk about this anymore.”
However, that is not all. As the article points out, the requirements of the FATCA act actually clash with Canada's own privacy laws. The US is asking Canadian institutions to do something in terms of client data collection they are not allowed to do. This creates a legal bind for them that goes well beyond the mere costs of compliance (the same problem is faced by institutions in many other countries as well).
“FATCA, which was passed into law in 2010, demands that every financial institution in the world identify all account holders who are “U.S. persons” — defined by the IRS as anyone who is a U.S. citizen, or even a U.S. landed immigrant or green-card holder — and report directly to the IRS on the status and balances in those accounts. Intended to catch U.S. tax cheats stashing money abroad, this huge net threatens to sweep up, along with a handful of tax cheats, those six to seven million U.S. expatriates living ordinary lives in other countries.
One significant challenge for Canadian financial institutions is the fact that Canadian and provincial right-to-privacy legislation prohibits them from sending financial information to a third party (like the IRS) without the consent of the account holder. While Canada’s major banks have taken strong positions on FATCA, the country’s credit unions are also caught up in the controversy and are actively pushing for changes. Collectively, they are not happy. “I’ve never touched a file before in which there is absolutely no public policy benefit, no benefit for Canada, no benefit for a Canadian credit union,” says Gary Rogers, vice-president of financial policy at Credit Union Central of Canada, the association that represents the country’s credit unions. “The burden to follow some rules imposed by a foreign government is quite disgusting. I’ve been trotting out that phrase from the 1960s — ‘Yankee Imperialism.’ I launched that with our board, and got a chuckle. But it is accurate.”
The end result, quite predictably, is this:
“None of the credit union officials would speculate on what their ultimate policy decisions will be — perhaps because the options are not very palatable. One of those options, and it’s one already being employed in other countries, is to simply get rid of all account holders with American ties, and refuse to open accounts for anyone with American connections. As draconian as that sounds, it is already happening in Asia and in Europe. If a financial institution can purge itself of all accounts with American connections, it won’t have any compliance issues with the U.S., and it won’t have to report anything to the IRS.”
Or to put it bluntly: the law effectively amounts to the introduction of capital controls through the backdoor.
Forcing Pension Funds to Buy Government Debt
Another example we have come across are laws and regulations that force pension funds to buy sovereign debt whether they like it or not. People are coerced into buying the debt of what are de facto, if not yet de iure, bankrupt governments. After all, without the ability to print money, many governments would have been forced into outright default already. Avoiding default by printing money is of course nothing but default by another name. As the FT reports:
“Pension funds will be forced to buy chunks of the trillions of US, UK and EU long-dated sovereign bonds to be issued over the next few years – but with disastrous consequences, experts say.
Solvency II-type regulations and financial repression – in which governments are pressing institutional investors to buy debt – will push pension funds to invest in government bonds. The problem, however, is that government bonds offer low-to-negative real returns that will eat into pension funds and increase those funds’ growing deficits. While financial repression can help governments to shrink debt, this type of policy is definitely not favourable to pension funds, says Jerome Booth, head of research at Ashmore.
“Financial repression works well, as it did after the second world war, but it is distortionary,” he says. “Whilst it’s good for the taxpayer, as a saver I think it’s outrageous. Anyone who invests money in sovereign bonds has got some explaining to do.”
Recent monetary policy in developed markets has already pushed down government bond yields, but experts say the situation could get worse. One concern is that over the long term, a period of high inflation or strong currency moves would lead to a great reversal of government bond prices.
Mr Booth adds: “In markets, risk is always moving. It’s not acceptable to shove people’s money into deposits or government bonds.”
'Acceptable' or not, it is being done. As the article notes, a veritable 'tsunami' of government debt issuance lies dead ahead, with the US alone expected to issue an estimate $5 trillion in new debt by 2017.
As Ludwig von Mises notes in 'Human Action' regarding investment in government bonds, there is no such thing as a 'risk free' investment that is independent of the wealth generated on the free market. Furthermore, over time, the government is forced to begin paying for all the capital that has been squandered in the past.
“Now, the irredeemable perpetual public debt presupposes the stability of purchasing power. Although the state and its compulsion may be eternal, the interest paid on the public debt could be eternal only if based on a standard of unchanging value. In this form the investor who for security's sake shuns the market, entrepreneurship, and investment in free enterprise and prefers government bonds is faced again with the problem of the changeability of all human affairs. He discovers that in the frame of a market society there is no room left for wealth not dependent upon the market. His endeavors to find an inexhaustible source of income fail.
There are in this world no such things as stability and security and no human endeavors are powerful enough to bring them about. There is in the social system of the market society no other means of acquiring wealth and of preserving it than successful service to the consumers. The state is, of course, in a position to exact payments from its subjects and to borrow funds. However, even the most ruthless government in the long run is not able to defy the laws determining human life and action. There are in this world no such things as stability and security and no human endeavors are powerful enough to bring them about.
If the government uses the sums borrowed for investment in those lines in which they best serve the wants of the consumers, and if it succeeds in these entrepreneurial activities in free and equal competition with all private entrepreneurs, it is in the same position as any other businessman; it can pay interest because it has made surpluses. But if the government invests funds unsuccessfully and no surplus results, or if it spends the money for current expenditure, the capital borrowed shrinks or disappear entirely, and no source is opened from which interest and principal could be paid. Then taxing the people is the only method available for complying with the articles of the credit contract. In asking taxes for such payments the government makes the citizens answerable for money squandered in the past. The taxes paid are not compensated by any present service rendered by the government's apparatus. The government pays interest on capital which has been consumed and no longer exists. The treasury is burdened with the unfortunate results of past policies.”
Mises put these words to paper in the late 1940's. Although he didn't use the term 'financial repression', it is evidently precisely what he deemed the ultimate outcome of the vast accumulation of government debt to be.
The Transaction Tax
Euro area governments are pushing ahead with the introduction of the 'transaction tax', which will will do untold harm to European capital markets and further diminish the shrinking incomes of citizens depending on their savings and investments. As numerous studies have shown, the tax will destroy far more revenue than it can ever hope to bring in. The reaction of Europe's political class: Let's do it anyway!
“Finance ministers from 11 European Union countries agreed at a meeting in Luxembourg on Tuesday to support a tax on financial transactions, hoping to discourage risky trading while simultaneously raising revenue.
Germany and France, the EU's two largest economies, have long supported the idea of the tax, while countries like the Netherlands, Sweden and the United Kingdom remained staunchly opposed out of fears the tax could harm the competitiveness of their financial markets.
Sweden imposed a similar tax in the 1980s, only to lose much of its trading activity to London. Stockholm later repealed the law. "We still think that the financial transaction tax is a very dangerous tax," Swedish Finance Minister Anders Borg said ahead of the meeting. "It will have a negative impact on growth."
There are still few details on how the tax — referred to as the "Tobin tax" after the Nobel laureate American economist James Tobin who first proposed it in 1972 — would work and how its revenue would be used. The European Comission, the EU's executive branch, has proposed taxing trades in bonds and shares at a rate of 0.1 percent per transaction and taxing trades in derivatives at 0.01 percent.
Some have proposed the revenue be put into a fund that would help struggling banks, while others — particularly Brussels — want the money to beef up the EU's budget. Austrian Finance Minister maria Fekter said that a model for how the tax might work would be presented by the end of the year in the hopes that it could be installed by 2014.
Talks on the tax are one element of European Union efforts to create banking rules that could help prevent a repeat of the debt crisis which continues to ravage euro-zone finances.”
Let us simply ignore Sweden's experience! Who cares about 'growth'? We must 'rein in risky trading'! This is such appallingly uninformed nonsense that one doesn't know where to begin. Have they no better things to do? Of course the officially intended 'victims' of the tax, namely financial institutions and the ever-present 'evil speculators' (on whose activities the market economy depends, a fact that has not once been mentioned or considered by the eurocrats as a result of their economic illiteracy) are definitely not the ones who will pay for this newest burden. Everybody else certainly will – first and foremost the proverbial widows and orphans. The tax will severely impair market liquidity, thereby raising spreads and diminishing the prospective investment returns of pension funds, mutual funds and other investment vehicles. The banks will simply pass the cost on to their customers – they are not going to pay a single cent. Speculators will decamp to more welcoming shores, which should permanently increase the equity risk premium in the countries imposing the tax, which in turn will make it more expensive for companies to raise capital. Meanwhile, anyone who actually believes that the financial crisis could have been averted by means of imposing such a tax urgently needs to have his head examined.
Negative Interest Rates, Inflation
Banks have begun to impose penalties on those who seek to escape the risks associated with the euro by fleeing into the currencies of Denmark and Switzerland. This is a result of the central banks in these countries attempting to discourage capital inflows by imposing negative deposit interest rates.
“State Street Corp. (STT) and Bank of New York Mellon Corp., two of the world’s biggest custody banks, will charge depositors to hold Danish kroner and Swiss francs as customers seek refuge from the crisis-stricken euro.
State Street will apply a negative interest rate of 0.75 percent annually to krone deposits starting Nov. 1, with a separate charge for francs, according to a note to clients last week. That means money managers, insurance companies and pension funds must pay the bank to hold their cash. BNY Mellon started charging for krone deposits last month, a person with knowledge of the matter said. The lender isn’t charging for francs.
Denmark and Switzerland have cut interest rates close to or below zero to keep the krone and franc from rising as investors flee the euro for safer havens, reflecting concern that the currency may break up. While negative rates may drive off some customers, global lenders want to restore the profit margin between what they pay for deposits and what they earn on investments.
“It does look customer-unfriendly, but since State Street’s mainly dealing with institutions I would think that people would be more understanding,” said Richard Herring, a professor of international banking at the University of Pennsylvania. “The overall problem is the distortions that are caused by the monetary policies that are being pursued in the major countries.”
Of course 'negative interest rates' are a liable to create even worse economic distortions than merely 'suppressed' interest rates. In the real world there can be no such thing as a 'negative interest rate'. The natural interest rate must always be positive – it expresses the discount of future goods against present goods. It is simply not possible for future goods to be worth more than present goods. Time preferences may in theory rise to something approaching 'infinity': for instance, imagine the hypothetical case that we find out that a comet will collide with the earth and destroy it within a week's time. Obviously there would no longer be any incentive to provide for the future and time preferences would increase accordingly.
However, it is logically impossible for time preferences to become 'negative'. And yet, a number of central banks have manipulated their administered interest rates into negative territory and several others are reportedly considering taking the same step. How that can result in anything other than even more misallocation of scarce resources remains unexplained by the bien pensants leading these institutions.
Der Spiegel on the Pernicious Effects of Inflation on Savings
Interestingly, the normally somewhat left-leaning German news magazine Der Spiegel has devoted its recent cover story to a report on the havoc inflationary policies inflict on savings and wealth. In fact, the cover gets it exactly right with its title:
Recent Spiegel cover: 'Attention, inflation! How Germans are dispossessed by stealth.'
Germans are avid savers, which is one of the chief reasons for the German economy's success. Moreover, the country's private sector is not plagued by the 'deleveraging' issues that are regarded as such a big problem in many other nations these days, as Germany's citizens tend to eschew debt. Not surprisingly, Germans are very concerned about the recent machinations of the ECB.
The article entitled “How Monetary Policy Threatens Savings” is well worth reading in its entirety. Here is how it begins:
“Central banks are currently flooding cash-strapped industrialized nations with money. This may help governments reduce their debt load, but it also erodes the value of people's savings. A massive redistribution of wealth is threatening to take place in Germany and Europe — from the bottom to the top.
Germany's central bank, the Bundesbank, has established a museum devoted to money next to its headquarters in Frankfurt. It includes displays of Brutus coins from the Roman era to commemorate the murder of Julius Caesar, as well as a 14th-century Chinese kuan banknote. There is one central message that the country's monetary watchdogs seek to convey with the exhibit: Only stable money is good money. And confidence is needed in order to create that good money.
The confidence of visitors, however, is seriously shaken in the museum shop, just before the exit, where, for €8.95 ($11.65) they can buy a quarter of a million euros, shredded into tiny pieces and sealed into plastic. It's meant as a gag gift, but the sight of this stack of colorful bits of currency could lead some to arrive at a simple and disturbing conclusion: A banknote is essentially nothing more than a piece of printed paper.”
We are astonished and delighted to come across such a frank and correct assessment of the situation in a mainstream news magazine. Already in the first paragraph one of the chief problems of the inflationary policy is correctly identified: “A massive redistribution of wealth is threatening to take place in Germany and Europe — from the bottom to the top.”
The article also has a chapter on 'financial repression' where this train of thought is explored in more detail. Interestingly, it even includes a fairly harsh critique of the manner in which the banking system and governments have become intertwined to the vast detriment of citizens and savers. Obviously in Germany the issue of financial repression is not glossed over so easily.
As the article notes:
“This is how the trick works: The central bank buys government bonds, thereby pushing the interest rates to levels below the rate of inflation. This means that inflation is greater than the growth in interest rates, so that real interest rates become negative. Put differently, inflation consumes assets. Or, to put it even more bluntly: Saving becomes pointless.”
A history of administered interest rates and 'CPI inflation' in Germany, via Der Spiegel
Do we really want 'saving to become pointless'? Central bankers continue to insist that this is 'necessary' in order to 'support the economy'. But how can the economy possibly be 'supported' by a policy that consumes capital? As Frank Shostak recently pointed out in this context:
“Regardless of psychological disposition, if the ability to generate final goods and services diminishes, it is not possible to boost overall demand for goods and services. We could convince individuals that the Fed's monetary pumping is going to revive the economy and therefore that it is in their own interest to start buying more goods and services. However, if the backup is not there — i.e., if there isn't an increase in the production of real wealth (final consumer goods and services) — it is not going to be possible to expand the overall demand.”
We hold that it is a fallacy to suggest that Bernanke's monetary pumping has prevented the US economy from falling into a severe depression. What Bernanke's policy has done is to prevent the removal of various non-productive, wealth-destroying activities that emerged on the back of previous loose monetary and fiscal policies.
Obviously, if Bernanke hadn't stepped in with massive pumping, a large amount of bubble activities would have been liquidated by now. This would have provided more real wealth to wealth generators and would have set in motion a genuinely solid economic expansion. This would have strengthened the economy's ability to generate real wealth.
By introducing another massive monetary-pumping scheme Bernanke is running the risk of inflicting more damage to the process of real wealth generation. Consequently, this raises the likelihood that we could remain in depressed economic conditions over a prolonged period of time.
It must be realized that the damage inflicted on the economy by reckless monetary and fiscal policies cannot be fixed by further aggressive monetary pumping and by lifting people's confidence in the Fed's policies.”
Amen to that – as we always point out, one cannot possibly 'print one's way to prosperity'. The exact opposite is in fact true: the policy diminishes the economy's ability to generate true wealth.
If anything, “we” are printing ourselves into the poorhouse.
Chart and graphics: Der Spiegel
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