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By Arnold Bock with Lorimer Wilson
A
new financial policy initiative known by the label "Financial
Repression" may soon become our worst nightmare. 'Repression' rhymes
with 'depression' which could be what we have to look forward to as rampant
price inflation and permanently lower living standards take hold. Get ready
to be conscripted into a citizen army assembled for the greater cause of
saving the nation from being swamped by a tsunami of debt. Let me explain.
What is Financial Repression?
Financial
Repression is a policy cocktail comprised of large doses of monetary
inflation, commonly known as money creation far in excess of the growth in
the economy, coupled with interest rates that are below the real rate of
inflation. While that may not sound particularly scary, the policy is
designed to cause asset and price inflation which is reflective of, and
caused by, a devaluing dollar. A much lower standard of living is the
inevitable outcome.
What's the Purpose of Financial Repression?
The
purpose of Financial Repression is to allow the US federal government to cope
with its overwhelming accumulated debt and unfunded promises for future
Social Security, Medicare, Medicaid and employee pensions. It also prevents a
proud nation from having to 'restructure' its debt as run-of-the-mill dead
beat nations periodically are forced to do. Insolvency is just plain
un-American for the world's largest economy, the only remaining super power and the owner of the world's reserve currency.
To declare the equivalent of a private sector bankruptcy is just not in the
cards.
In
order to make Financial Repression work, the FED needs to keep a cap on
nominal interest rates preferably at four percentage points below the real
rate of price inflation. Aside from the highly negative impact of decimating
the nest eggs of citizen-savers, it has the beneficial effect of inflating
away debilitating, pesky and otherwise unmanageable financial obligations of
the federal government.
Will Financial Repression Work?
A
four percent interest rate below the real rate of inflation, compounded over
ten years, reduces in half the 'real' value of payments to the government's
debt holders and entitlement recipients. Imagine what it does to the
purchasing power of social security payments. Everyone gets the number of
dollars promised, but they just don't buy as much. Magical, isn't it,
especially if citizens think they are getting richer because their pay checks
rise and their houses start to increase in price, thanks to inflation.
In
the absence of large foreign buyers of US government debt, we the citizens will
be conscripted to fill the gap, all for the greater good of the nation's
future. A captive audience of citizen-savers and investors are expected to be
a compliant army of civic minded patriots herded into the role of federal
bond buyers in order to save the nation for future generations of Americans.
Of course we will be assisted by the FED with a rejuvenated and renamed QE3
program...designed to drive dollar devaluation and inflation.
How Will Financial Repression Work?
So
how will this new and improved effort at national financial rejuvenation and
restoration scheme work? A fixed percentage of all pools of capital -
including savings, investments, pension and retirement funds of individuals
and institutions - will be mandated to own Treasury bonds as a part of their
savings and investment portfolios.
Will Financial Repression Be Voluntary?
As
with all conscriptions involving a national crisis, this one will be anything
but voluntary. Your personal 401k and IRA are likely to be conscripted to
become part of this greater good. Bank assets, insurance company investments,
university and other public institution endowments, pension funds and
virtually all pools of money will be forced to join the cause of the greater
good for America's future.
How Can Financial Repression Be Avoided?
You
could decide now to place some of your money in more friendly investments
than US federal government bonds. Bill Gross, head of the nation's largest
bond fund, took exactly this decision a few months ago by unloading all of Pimco's US government bonds. However, it is entirely
probable that Pimco will find itself owning US
Treasury paper once again.
If
you decide to transfer some of your cash outside the country you should do it
soon simply because 'Capital Controls' restricting the movement of money
outside the US are likely to become increasingly problematic. Rules are
already in place to restrict money laundering derived from illicit drugs or
the movement of money which facilitates terrorism. Expect more restrictions
under the guise of fighting drugs and terror when, in fact, it is designed to
ensure there is a large and captive market for increasingly unmarketable
Treasury debt.
When Will Financial Repression Begin?
When
does this process get underway? As soon as possible, but given the
inclination of politicians to present purely positive pictures prior to
elections, one could reasonably conclude that it will not be implemented, or
talked about publicly, until after the November 2012 election. Political
leadership on this issue will remain invisible until electoral risk subsides
or until there is absolutely no alternative to a rapidly burgeoning debt
crisis.
What Will Cause Financial Repression to Commence?
Financial
Repression will be imposed upon us when normal market demand for the
massively growing quantities of US Treasury debt dries up. China, the biggest
foreign customer for US government bonds, is developing a bad case of cold
feet when it considers US Treasury bond 'investments'. Instead they are
mopping up the world's natural resources from their pot of surplus dollars
derived from burgeoning manufactured exports. The Japanese now need to cash
in their Treasury debt to pay for tsunami damage, essentially dropping them
to bit player status in the bond market. The Saudis and other mid-east oil
Sheikdoms need their US petrodollars to buy protection and to insulate
themselves from the unsettling consequences of the 'Arab Spring.'
Why Financial Repression is Coming - to YOU
If
foreign buyers with the deepest pockets are deserting the regular Treasury
auction of bonds, notes and bills, who is available to pick up the slack? The
existing official debt is $14.3 Trillion and the current year fiscal deficit
is projected to add another $1.7 Trillion. Since much of the 'old' debt
continues to mature, it too must find new purchasers.
These
troubling realities leave US domestic buyers to do the heavy lifting of
buying US government debt. Who might these US domestic buyers be? Think FED
and its $100 Billion of magical digital dollars per month, or $600 Billion in
total, over the past six months under the guise of Quantitative Easing,
commonly known as QE2. While difficult to confirm, it would appear that the
FED has bought approximately 70 percent of the debt during this period. What
about the period immediately ahead now that the FED says it will stop the QE2
program?
Why Financial Repression is Unavoidable
US
sovereign debt is VERY serious. It currently stands at $14 Trillion - the
allowable ceiling. Moreover, the federal government is presently running an
annual deficit of $1.7 Trillion with deficits of similar dimensions projected
into future years. As such, Congress is now playing political games for voter
consumption which will lead inevitably to raising this debt head room by a
further $2 Trillion, thereby allowing current politicians to get re-elected
in November 2012. Given the fact that 42 cents of every dollar spent by the
federal government is borrowed money, not tax dollars, the debt ceiling is
going to have to be lifted, year after year, by Billions of additional
dollars.
That
is not the worst of it, however. Projected future deficits are even more
overwhelming in that promises to citizens for Social Security, Medicare,
Medicaid and other obligations for other services are mind numbing in scale.
The worst part is that these promises are dramatically underfunded. Depending
on whose numbers are used, what assumptions are made about future economic
growth, inflation, rates of interest and similar considerations, unfunded future
liabilities range from $60 Trillion to over $100 Trillion. Obviously, growth
of the economy and massive tax increases are totally incapable of meeting the
debt challenge.
What Can We Expect to Unfold in Years to Come?
Citizen
taxpayers and benefit recipients should expect more and higher deficits
forcing an ever growing mountain of debt. Current fifty year low interest
rates are guaranteed to rise which will make servicing the humongous debt an
insurmountable challenge. So what is going to happen?
The
U.S. could declare "Banana Republic" style insolvency and embark
upon debt restructuring, but that would be the 'easy' route out of the debt
morass. The US is the world's largest economy, the only remaining super power
and owns the world's reserve currency. Alpha nations like the US don't
declare the public sector equivalent of a private bankruptcy.
Instead,
the US and other first world economies that are reaching similar zombie debt
status, will adopt brutally tough austerity measures starting with painful
reductions in social security and health care benefits. Tax increases should
be expected too, as well as ever more digital dollar printing.
The
end result of Financial Repression will be rampant price inflation and
permanently lower living standards. Get ready to be conscripted into a
citizen army assembled for the greater cause of saving the nation from being
swamped by a tsunami of debt.
Arnold Bock
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