Financial Despotism and Government Schemes April , 2012
Habitually in a normal world, when economies are in trouble, growth is lethargic and stock markets have an intrinsically high level of volatility. Investors tend to apply the logical expression “fly to safety” in their financial strategies, meaning that investors are keen to have long-term government bonds every time they perceive economic instability. This category of “standard” investment strategy under economic distress was considered a normal answer to standard central bank intervention during economic tribulations. Frequently when the economy is under some sort of recession or contraction, the central banks usually intervene in the monetary system aiming for some rapid stimulus. This is achieved by lowering the short- term interest rates close to zero, which enhance consumption and self-reliance. When that happens, government bonds (which are guided by longer term interest rates) experience positive returns. In contrast, there will be some financial assets with shorter maturities, which would not experience positive returns (because they are anchored to the behavior of shorter rates artificially manipulated and lowered by central banks). This sort of approach is usually referred to as “riding the yield curve” which assures some positive gains for investors in the long run.
Unfortunately we are not in a regular world any longer. Our current state of affairs is one in which even long-term interest rates are also distorted by central banks in an effort to fully intervene and flatten the entire yield curve. This condition however is not atypical in human history: we have experienced this right after the end of the World War II. During that time, the long-term government bonds yield was around 2 per cent. Throughout that interlude of manipulation, the US government debt to GDP fell drastically from 116 to 32 per cent. Until today, this sort of “government deleveraging” had never been so drastic and effortless.
In an efficient world with free moving capital, the narrative should be quite diverse. If a government aims to reduce their debt through economic distortions caused by negative long- term interest rates, investors would anticipate the move and ask for higher compensations. In the worst case scenario, they would look for an alternate safe investment in some other sobering debt market, withdrawing their capital and trust in the previous government debt (which had tried to succeed in the intervention scheme). This however was not the case during the post World War II period; the Bretton Woods arrangement established capital controls in 1946 so that investors were restrained with keeping their money at home and having to deal with the governments yield intervention to pay their outstanding debts.
Consequently for almost 30 years, investors lived with negative real interest rates, because of this class of western government’s intervention and expropriation of wealth. It was then what economists call “financial repression”.
Returning to our current events, the sort of “financial repression” is much more difficult to achieve nowadays than during the Bretton Woods agreement. Now investors have very flexible and free mobility of dispersing their capital throughout the world. This allows them to avoid numerous varieties of home-land authoritarianism. Especially the kind in which, some local government would try to achieve negative real interest rates to pay off their debt.
Unfortunately this is not quite what is happening in the world. What we have experienced since last year is a class of “financial oppression” similar to the one experienced during the agreement in New York, even if the pact was dissolved long time ago.
What we seem to be experiencing, is a situation in which the majority of the biggest and most powerful western central banks have unrestricted and simultaneously intervened their bond markets with massive government bonds purchases. This distorts long-term interest rates and flattens worldwide bond yield curves. This massive, systematic and organized central bank bond market intervention is something the world has never experienced before. And it is the obvious interventionist answer to free capital mobility, similar to the one which Bretton Woods established (western central bankers established it in the 40’s with the intention of control capital and create “financial authoritarianism”). Thus what we see now is again the same intrusion as 70 years ago, but with a different façade. The central banks conduct this sort of coordinated and discretionary intervention now in unison. This is precisely the sort of interference needed to create a global “financial subjugation” and the only way that western governments can simultaneously and discretely deleverage their debt in a painless way.
So what we see currently is negative long-term interest rates in most of the world’s financial capitals: the US, China, Europe and the UK are simultaneously experiencing negative real rates. The outcome is the decrease of the outstanding debt’s real value of, both public and private. Once again, as 70 years ago, savers are the ones paying the price for excessive and bubble-fed debt, out of control private leveraging, consumption beyond consumer’s capacities of repayment, and uncontrolled and unsustainable western welfare government expending.
The losers in this saga are once again retail long-term investors and normal Main Street savers, which see their real purchasing power capacity reduced each time central bankers bloat the economy with money printing. As Maria Belen Sbrancia of the University of Maryland recognized in a recent working paper, “The negative real interest rate, provided a subsidy to the US government equivalent to 2.3 per cent of GDP a year between 1945 and 1980”.* This effectively showed us why it is convenient for central banks and governments to simultaneously create this environment of negative real interest rates around the financial globe.
Unfortunately, this sort of scheme brings a deplorable signal for the whole society. When savers get to be socially punished and see their real savings diminished and in contrast, the over deleveraged consumers, speculator, investors and over-indebted governments always get the benefits. This indicates that something is incorrect in the way societies deal with irresponsible debt.
Under this situation then savers and the whole society start to question themselves: why should we, as society, worry about our increasing debt and lack of savings? Why not better ride the scheme the same way the government and too-big-to-fail institutions do? Sadly, if we as a civilization end up reasoning like that, then the whole pool of real savings in society will soon deplenish. This dampers the possibilities of further sustainable growth: real savings are the genuine source of long-term sustainable real growth, not monetary paper based stimulus. Unfortunately this “financial repression” plot ultimately only discourages people to save and governments to misbehave economically. This leads to an end result of over-consumption sustained only by asset’s stimulation and government activities, rather than industrial production based on productivity and real savings.
The time will arrive when; the real pool of savings can no longer sustain productive and competitive activities because it was being systematically deplenished by negative (moral or monetary) incentives. Then the scheme of “financial despotism” will be set in motion once again, therefore monetary long-term intervention and government spending will artificially uplift the economy (probably funding non-productive or non-competitive activities), increasing government debt as a percentage of GDP to unsustainable levels. At the same time this will benefit the conniving planners with real long-term yields reducing the burden and easing their misbehavior.
History then repeats itself but society nonetheless shuns the fundamental lesson that the Great Depression and unsustainable government expenditures post World War II taught us. Our new “financial despotism” situation disappointedly accompanies us once again in this
* M Belen Sbrancia, “Debt, Inflation, and the Liquidation Effect,” working paper, August 2011