Negative interest rates and financial repression

Author: Mark Thornton, Mises.org

We are constantly told that unprecedented levels of money printing by the Federal Reserve and other central banks are necessary to stimulate the economy, create jobs, and generate economic growth. The truth is that this is a scheme to covertly steal purchasing power from the productive class and redistribute it to the unproductive financial class and the counterproductive political class.

Financial repression

Given that politicians and central bankers seem to have gone crazy in their obsession with money printing and ultra-low interest rates, it's good to know that economists have a term for what's happening right now. That term is "financial repression."

This is not a new term. Its use dates back to at least 1973, when two Stanford University economists, Edward Shaw and Ronald McKinnon, used the term in separate publications. The phrase was originally used as a criticism of a number of policies that lowered economic growth rates in underdeveloped countries, rather than as a label for the policies of leading modern economies.

Financial repression consists of a set of policies through which the government covertly drains wealth from the private sector and facilitates the financing of government debt. In modern terms, this includes:

1. A zero interest rate policy, where many of the world's leading central banks keep their interest rates at around 0%. Obviously, this keeps interest rates on government debt lower than they would otherwise be, i.e. makes it cheaper to finance.
2. So-called "quantitative easing" - the central bank buying government debt from private banks. This increased demand increases the price of government bonds and lowers their interest rates, i.e. again - makes them cheaper to finance.

These are the two most essential policies of financial repression today. The combination of these two policies allows governments to borrow money, in the form of both long-term and short-term bonds, at extremely low interest rates. This in turn keeps interest payments on government debt relatively low.

Other signs of financial repression in the US include requirements that banks hold government bonds as part of their core capital requirements, a requirement that was strengthened by Basel III. Other such signs include high reserve requirements, which are effectively met by paying interest on those reserves, and restrictions on the free movement of capital, which restrict or tax the export of wealth. And last but not least, there is the " War on Cash ", i.e. restrictions on cash payments.

All of these policies fall under the umbrella of "macroprudential policy," through which government bureaucrats hyper-regulate the entire financial industry. Macroprudential policy provides another aspect of financial repression: government control or direct ownership of banks and financial institutions, combined with barriers to competition in the market for banking services. It's hard to define macroprudential policy precisely, but it seems to mean a group of unwise policies that only make sense if you're trying to deepen the macroeconomic mess we're already in.

Negative interest rates?

When you combine financial repression with bail-in provisions for banks and unstable currencies, you get the almost unimaginable phenomenon of negative nominal yields on government bonds. A number of European countries are already selling bonds with negative yields, so that those who pay more than €1,000 for a given bond will receive less than €1,000 when it matures.

Why would anyone accept such a deal when you can just keep that 1000 euros in cash? People naturally tend to keep their money in the bank if they don't want to risk it. So people with a lot of money don't want to keep a few million in cash. So they prefer to keep it in the bank and accumulate some interest.

The problem with this approach is that banks do not pay interest and, more importantly, some governments have implemented "bail-in" regulations for large, systemically important banks, similar to what happened during the Cyprus financial crisis. Such regulations mean that depositors will lose a percentage of the money in their uninsured deposits in the event of financial difficulties for the bank. The alternative is to exchange uninsured bank deposits and bonds for shares in the bank, so that depositors are effectively forced to capitalize it.

So it might make sense for wealthy depositors to pay negative interest rates on government bonds if they believe that governments are more reliable institutions than banks.

An alternative explanation for investors' willingness to buy bonds with negative interest rates is unstable currencies and exchange rates. If I live in the Eurozone and expect the euro to fall against the Swiss franc or Norwegian krone, then buying Swiss or Norwegian government bonds with negative nominal interest rates could be a profitable operation compared to buying bonds denominated in euros.

The effects of poor management

Financial repression is the result of bloated government budgets and huge public debts. It is the worst way to deal with public debt and is actually contrary to the adequate measures needed to deal with fiscal problems, which include: cutting government programs and all kinds of spending, saving by laying off government employees, their salaries and bonuses, as well as deregulation and privatization to achieve higher economic growth.

The effects of financial repression cause economic harm to all productive sectors, workers, savers, productive entrepreneurs and retirees. It harms the insurance sector, which has the function of securing our lives, health, property and homes. The economic winners are the big banks, financial institutions such as those on Wall Street, the state itself and certain large corporations.

Traditions of bad governance

In Siena, Italy, a 14th-century fresco called "The Allegory of Good and Bad Government" is located in the town hall building in Piazza del Campo. Good government is based on peace, stability, prudence, honesty, and self-control with a special emphasis on justice. The results of good government are depicted on the right side of the fresco as prosperous trade, productive labor, and good material conditions.

Across the room is the mirror image of bad governance. It is based on cruelty, lies, deceit, anger, division, war, greed, arrogance, and excessive pride. The effects of bad governance are depicted as a city in ruins, houses in ruins, and no commerce except the making of armor and weapons. The city streets are empty, and in the countryside two armies are preparing for war.

On the side of good governance, an image of justice sits on a throne. On the other side of the room, an image of tyranny sits on a throne. The panoramic fresco is a breathtaking work of art and an extremely accurate depiction of reality. Financial repression is simply the most recent modern addition to the toolkit of bad governance.

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