|
Before I begin today’s essay,
yesterday I said that gold and silver were the new king of safe havens and
then yesterday gold and silver proceeded to sell off with a vengeance. I sure
looked foolish yesterday (and I received more than my fair share of barbs
from readers who told me so) but what I want to point out is that by 8PM
yesterday gold had climbed back over $30.00 an ounce and silver also followed
along. As I write this gold is up $25.00 from yesterday’s close at
$1837.00 and silver is up $1.50 to $42.00.
Yesterday’s selloff of gold was
the catalyst for the market spike and it was a very healthy event for gold
which was long overdue for a break. My timing was about as bad as possible
but what I believe today is the same as I believed yesterday when I wrote
that – there is simply no place left to hide besides gold and silver.
"Financial Repression" is
currently a hot buzzword in the global economic community, and its effects
are even worse than it sounds. Like other recent economic buzzwords such as
"monetary sterilization" and "quantitative easing", the
average person will never understand the meaning, if they hear the phrase at
all. That is too bad, because governments around the world are deliberately
and methodically stripping wealth from hundreds of millions of people is the
quite explicit objective of Financial Repression.
As published in a recent working paper
on the IMF website, Financial Repression is what the US and the rest of the
advanced economies used to pay down enormous government debts the last time
around, with a reduction in the government debt to GDP ratio of roughly 70%
between 1945 and 1980. Financial Repression offers a third way out - as it
allows governments to pay down huge debt burdens without either 1) default or
2) hyperinflation. If you are a senior government official of a nation that
has a huge "sovereign debt" problem – like the United States
and almost all of Europe, and you want to stay in power - this proven method
is a topic of keen interest.
To understand this miraculous debt
cure for governments, you need to understand the source of the funding. The
essence of Financial Repression is that the government deliberately destroys
the value of money over time, and uses regulations to force a negative rate
of return onto investors in inflation-adjusted terms, so that the real wealth
of savers shrinks by an average of 3-4% per year.
What the IMF-distributed paper really
constitutes is a “Sheep Shearing Instruction Manual.” The way out
for governments is effectively to put the world's savers and investors in
pens, hold them down, and shear them over and over again, year after year. Uninformed
and helpless victims are what make Financial Repression work, and it worked
very well indeed for 35 years. On the other hand, if you understand what is
truly going on, then you do have the ability to turn this to your substantial
personal financial advantage. With a genuinely out of the box approach to
long-term investment, the more heavy handed the repression - the more
reliable the wealth compounding for those who reject flock thinking.
The advanced Western economies of the
world emerged from the desperate struggle for survival that was World War II,
with a total stated debt burden relative to their economies that was roughly
equal to that seen today. The governments didn't default on those staggering
debts, nor did they resort to hyperinflation, but they did nonetheless drop
their debt burdens relative to GDP by about 70% over the next three decades -
and the very deliberate, calculated use of Financial Repression was how it
was done.
The specifics of financial repression
took somewhat different forms in each of the advanced economies, but they
shared four characteristics: 1) inflation; 2) governmental control of
interest rates to guarantee negative real rates of return; 3) compulsory
funding of government debt by financial institutions; and 4) capital controls.
<!-Inflation.
First and foremost, a government that owes too much money destroys the value
of those debts through destroying the value of the national currency itself.
It doesn't get any more traditional than that from a long-term, historical
perspective. Without inflation, Financial Repression just doesn't work.
Historically, the rate does not have to be high so long as the government is
patient, but the higher the rate of inflation, the more effective financial
repression is at quickly reducing a nation's debt problem.
NNegative Real Interest Rates. In a theoretical world, some would
say that governments can't inflate away debts because the free market would demand
interest rates that compensate them for the higher rate of inflation. Sadly,
this theoretical world has little to do with the past or present real world.
In the past (and all too likely in the
future), there were formal government regulations that determined the maximum
interest rates that could be paid. As an example, Regulation Q was used in the United States to
prevent the payment of interest on checking accounts, and to put a cap on the
payment of interest on savings accounts.
Regulation Q is long gone, but
government control of short term interest rates has been near absolute over
the last decade in the United States. So long as the Federal Reserve keeps
control, there is no need for explicit interest rate controls. However,
should the Fed begin to lose control, there is a strong possibility that
interest rate controls will return to the US financial landscape, with
similar regulatory controls being re-imposed in other nations.
Involuntary
Funding. With this
popular component of Financial Repression, the government establishes reserve
or "quality" requirements for financial institutions that make
holding substantial amounts of government debt mandatory - or at least
establish overwhelming incentives for financial institutions such as banks,
savings and loans, credit unions and insurance companies to do so. Of course,
this is publicly phrased as "mandating financial safety", instead
of the more accurate description of mandating the making of investments at
below market interest rates to help overextended governments recover from
financial difficulties.
This involuntary funding is sometimes
described as a hidden tax on financial institutions, but let me suggest that
this perspective misses the important part for you and me. Because all
financial institutions operating within a country are required to effectively
subsidize this liquidation of government debt by accepting less than the rate
of inflation on interest rates, the gross revenues of all financial
institutions are depressed, and therefore less money can be offered to
depositors and policyholders. Because financial institutions make their money
not on gross revenues, but on the spread between what they pay out and take
in, then arguably, financial institution profits are not necessarily reduced,
rather the guaranteed annual loss in purchasing power is passed straight
through to depositors and policyholders, i.e. you and me.
As an example, if a fair
inflation-adjusted return were 8%, and the spread kept by the financial
institution was 2%, then we as investors would get 6%. If financial
institutions, through involuntary funding, are uniformly forced to accept a
3% return on the government debt that must constitute a big portion of their
portfolios, then they still keep 2%, but only pass through 1%. So the
financial institution keeps 2% either way, and we as savers are the ones who
ultimately pay this "hidden tax" in full, by getting a repressed 1%
instead of a fair market 6% return.
CaCapital Controls. In addition to ongoing inflation that
destroys the value of everyone's savings and thereby the value of the
government's debts, while simultaneously making sure that interest rate
levels lock in inflation-adjusted investor losses on a reliable basis, there
is another necessary ingredient to Financial Repression. Participation must be mandatory.
The government has to make sure that
it has controls in place that will keep the savers in place while the
purchasing power of their savings is systematically and deliberately
destroyed. This can take the form of explicit capital and exchange controls,
but there are numerous other, more subtle methods that can be used to
essentially achieve the same results, particularly when used in combination.
This can be achieved through a combined structure of tax and regulatory
incentives for institutions and individuals to keep their investments
"domestic" and in the proper categories for manipulation, as well
as punitive tax and regulatory treatment of those attempting to escape the
repression. The carrot and the stick approach makes
sure that behavior is controlled.
Only a tiny fraction of 1% of the
world's population will ever read the original paper on the IMF website, or
detailed analyses thereof. This is dry and boring stuff when compared to
dancing or singing with the stars! Of course, there are many millions of investors
who do read daily or weekly about what is going on in the financial world -
but they and the journalists and bloggers who inform them usually just follow
the ever changing surface of the markets. Again, the academic papers involved
are so dry, boring and fundamental as to seem to
have little relevance for the practical matter of what actions to take today
or this month.
Having said that let me suggest that
few things are more important for your financial future than understanding
and taking to heart Financial Repression. Because understanding Financial
Repression means pulling the curtain aside and looking into the inner core of
financial reality. It means understanding that much of what you have read and
been taught about investment markets and long term investments over the last
several decades has effectively been a sham.
Investor returns are not and have
never been about people compounding wealth in free markets. Rather,
investments, investment markets, investor returns and investor behavior have
always been matters of governmental policy; what have varied over the years
have been the form of government policy and how overt the control is.
The governments of the world are in
trouble, and they would prefer to avoid overt global defaults, hyperinflation,
or comprehensive austerity coupled with massive tax hikes. Each of those
routes is highly unpopular, and could lead to political turmoil that would
remove the decision makers and the special interests who
support them from power. A more overt "managed economy" sounds much
more attractive if you are in power, particularly since it has worked before
over a period of decades, with an almost boring lack of political turmoil.
To get out of trouble, the governments
have to wipe out most of the value of their debts, without raising taxes to
the degree needed to pay the debts off at fair value. In other words, they need to cheat the
investors. There is nothing accidental going on here. All that is
in question are the particulars of the strategies for cheating the investors,
meaning the collective savers of the world. Again, the time-honored and
traditional form that governments who incur too much debt use in cheating the
investors is to devalue the currency. Create enough inflation, and tax
collections will rise with inflation but the debts won't, and the savers of
the world will be paid back in full with currency that is worth much less
than what was lent to the governments in the first place.
There is a way to beat Financial
Repression. The first step is to stop thinking like a sheep and start
thinking like a shepherd. Stop acting like a sheep, and change your financial
profile so that it aligns with the objectives of the "shepherds",
the governments of the world.
Instead of fighting the governments of
the world - position yourself so that the higher the rate of inflation and
the greater the destruction of the value of money - the greater your real
wealth grows, in inflation-adjusted terms.
The fundamentals of Financial
Repression are for governments to pin down their citizens, force them to take
interest rates that are below the government-induced rate of inflation, and
make it almost impossible for an older investor with a conventional financial
profile to escape. This is a time to fight the good fight politically - but
not with your savings or your future standard of living.
Instead, align your financial
interests with your government and the governments of the world. So that the
more outrageous the government actions become in squeezing the value of
investor savings from their populations - the more reliable the compounding
of your wealth becomes for you, and the greater the
growth in your financial security.
So how does one stop thinking and
acting like a sheep? This can be amazingly simple, or it can be impossibly
difficult. It is you and the way your mind works that will determine whether
thinking like a shepherd will become simple or be impossible. How open are
you to changing the way you view investments and financial security? Can you
change the personal paradigm that may have shaped your worldview for decades?
View the investment world in the way
in which we have all been programmed, and maintaining wealth over the coming
years of inflation and Financial Repression is going to be extraordinarily
difficult, particularly in after-tax and after-inflation terms because
everything around you really is set up for sheep shearing. That's not a
conspiracy theory - that is how the world really worked between 1945 and
1980, and policymakers around the world likely see variants of this proven
debt reduction methodology as their only way out.
The “Great Sheep Shearing”
of the early 21st century is already in process (we're just using some
different names and methods this time around), and it will likely succeed
with the overwhelming majority of investors - much like it did before, only
on a more thorough basis, because the problems are far larger this time
around. Whether Financial Repression will successfully prevent a meltdown is
a different question, but regardless, the attempt is still likely to dominate
markets as well as government regulations and policy.
Your alternative is to accept the
world as it is, take personal responsibility for your own outcome, and
educate yourself. You can seek to fundamentally change your paradigm, turn it
upside down - and personally turn that same world of high inflation and
Financial Repression into a target-rich environment of wealth building
opportunities.
|
