Taxes haven’t gone up yet, but inflation and lost productivity amount to financial repression.
It’s a $4.5 trillion week in Washington. Between the infrastructure and reconciliation bills in various stages of debate, it’s worth discussing in some depth how all this will be paid for. Government spending is conventionally understood as a matter of increased taxation and debt, a framing that has the virtue of being true. But that conversation is incomplete without also exploring the concept of financial repression—which ultimately underlies both the taxes and debt.
When the term was coined in the 1970s (by Stanford economists Ronald McKinnon and Edward Shaw ) it referred primarily to the dysfunctions of the banking systems in spendthrift developing countries. Governments would suppress interest rates on domestic savings to below the rate of inflation to reduce rates on lending. The point was to service government borrowing and subsidize credit to politically favored industries. In the process, they’d create a substantial wealth transfer from private creditors to debtors, leaving creditors with less purchasing power in the future while easing the real burden of debt repayment over time.
In emerging markets, this downward pressure on the interest rate paid on savings often still is accomplished via state ownership or effective public control of the banks. State domination of the financial system also facilitates the allocation of capital on the most favorable terms to politically connected borrowers. Developed economies have deployed this gimmick too. Regulation of the rates banks paid on savings was an important, and not the only, bit of financial repression perpetrated against Americans by the federal government in the lead-up to and aftermath of World War II.
That was a simpler era, and the understanding and practice of financial repression has grown more sophisticated alongside the evolution of the global economy and financial system. Banks in many countries remain important vectors for stealing from savers, but no longer are they the only accomplices (witting and willing or otherwise).
Financial repression nowadays consists of several overlapping phenomena beyond the classic suppression of bank interest rates. A nonexhaustive list: more-intrusive management of assets and credit allocation in the banking system via reserve requirements, capital regulations and the like; a blurring of the line between fiscal and monetary policy such that monetary authorities subsidize the fiscal authority’s borrowing while the fiscal authority creates new credit subsidies for other parties; and any press release from Sen. Elizabeth Warren demanding a new regulation on this sort of lending or that sort of borrowing.
We’ve had all of these tricks and more (including various European versions of Ms. Warren) robbing savers across developed economies since the 2008 financial panic, and even more since the pandemic started last year. You’ve got your historically low interest rates from the Federal Reserve and other central banks. You’ve got your capital-adequacy ratios and reserve requirements that press-gang banks into accumulating the government-issued debt conveniently classified as “safe” under the rules, and that soon will privilege “green” assets, too.
You’ve got your effective Fed backstop on municipal bonds and all the new Congress-created lending programs, many of them environment-related, that inevitably litter any Washington spending plan these days. You’ve got Ms. Warren demanding the ouster of Fed Chairman Jerome Powell, who still allegedly believes in some vague role for markets in credit allocation, in favor of Lael Brainard, who is said to favor a heavier regulatory hand.
A gaze through the lens of financial repression offers a new view of how dangerous Washington’s spending boondoggles are.
Because the debt must be repaid, a deficit borrows from future productivity to fund current spending—but this isn’t paid back only in future tax payments. Unfettered government spending also forces voters to pay via inflation and low returns on savings in the here and now.
More deeply, a discussion of financial repression prompts a reflection on productivity. The redirection of savers’ resources to politically favored “borrowers” (either directly via loan guarantees or more often indirectly via the disbursement of government grants raised via deficit financing) creates inefficiency and waste. If those loans were economically sensible—justified by a reasonable guess about the productivity the investment would create—the subsidy wouldn’t be necessary. Financial repression happens in the first place because the project the politician wants to spend money on is a productivity clunker, at the cost of fruitful investment in innovations that would permanently increase living standards.
It’s in this way, via rampant misallocation of capital and the attendant distortions of saving and investment, that Washington’s current spending binge won’t only borrow from the future. It will create a materially worse future, for which we all will pay one way and another.
Appeared in the August 13, 2021, print edition.
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