Financial repression arrives not with a bang but with a whisper. “It is a very stealthy tax,” says economist Carmen Reinhart of the Peterson Institute for International Economics. Reinhart is the toast of economic circles these days for speaking out about the newest way Western governments are using financial repression to liquidate their debts, particularly after a financial crisis. They’re doing this on the backs of savers, including pension funds, according to economists. In practice, financial repression can lead to “the rape and plunder of pension funds,” Reinhart tells Institutional Investor. Financial repression consists of very low nominal interest rates combined with captive lending by large banks or pension funds to a government. The low, stable interest rate facilitates the servicing costs of large public debts. Sometimes modest inflation is added to the mix. This results in zero to negative real interest rates that reduce government debt. Hence, broadly defined, financial repression is a wealth transfer from savers to debtors using negative real interest rates — with the government as one of the key debtors.
“Financial repression is manifesting itself right now,” says Reinhart, who works at the nonpartisan Washington-based research institute chaired by Pete Peterson, co-founder of Blackstone Group.
Low interest rates are a fact of postcrash economic life, designed to kick-start greater borrowing. However, these rates tend to be combined with regulatory measures that give preferential treatment to holders of government debt. Reinhart outlined examples in her recent paper “Financial Repression Redux,” written with Peterson Institute colleagues Jacob Kirkegaard and M. Belen Sbrancia. The authors assert that governments — in France, Ireland, Japan, Portugal, Spain and the U.S. — are taking steps to create captive markets for their debt. The subtle, perhaps unnoticed result is a new form of taxation: financial repression.
Interestingly, Reinhart does not denounce this new tax. “Financial repression is an expedient way of reducing debt,” she says. For banks as well as the government, debt overhang is a major economic problem. But every tax has costs, including distortionary effects. Because financial repression punishes savers, it’s unknown to what degree it inhibits savings. What is clear is that all the elements are in place for more financial repression in the U.S. In the wake of Dodd-Frank, public sentiment is moving against laissez-faire capitalism. Reinhart’s advice for pension funds facing this potential onslaught is simple: “I think awareness is the first step to being able to do something about it.”
