Notes From Underground: Financial Repression, European Style

Readers of the Notes From Underground have long been aware of Carmen Reinhart’s work on financial repression. Professor Reinhart has done copious research on government’s ability to force “citizens” to pay for all types of policy mistakes by inflating the financial system to reduce the wealth of savers for you can’t repress those with no savings or wealth stored in financial assets. The Romans would clip the edge of coins so as to repress its citizens by stealth depreciation. The United States after World War II, froze interest rates so as to reduce rate expenditures on a vast amount of accumulated debt. The Bernanke Fed has repressed savers by forcing interest rates down to negative real yields in an effort to revive a stagnant economy and relieve the massive debt overhang that was preventing a resurrection of consumer demand.

When Ben Bernanke and Chair Yellen have been challenged on the issue of financial repression their reply has been that savers are part of a greater economic polity. While the interest on their savings may have been reduced to less than inflation, savers have been rewarded in many other ways. The Fed Chairmen have put on their kindergarten teacher’s hat and explained how all people in society have benefited from the ultra low interest environment.

  1. If you own a house the stabilization of the construction industry has probably resulted in your home being worth more;
  2. If you have a child or relative searching for a job they may have benefited from the positive outcomes of a low interest rate policy;
  3. Your pension fund and retirement plan will have greatly benefited from the wealth effect of the portfolio balance channel.

The bottom line is that savers are not uni-dimensional and should be content with the zero deposit rate on your savings. The FOMC has thus claimed victory over the desultory effects of a deflationary spiral and we as a nation should be thankful. No financial repression here.

This is to refresh ourselves because this will be the mantra of ECB President Mario Draghi. The German press is alive with the cries of financial repression as the  German financial and social backdrop is one of frugality and thrift. Michael Pettis would of course argue that the German propensity to save is in fact a political policy and fosters the continued growth in the mercantilist industrial engine and its world’s largest current account surpluses. Regardless, the end result is that German depositors are feeling the effects of the ultra-low interest rate policy of the ECB and the recent decision to GO NEGATIVE fans the flames of the newspaper headlines. The Germans will yell repression and Mario Draghi will wave his finger and tell the German kinder to remember they are part of a larger project and their savings are being utilized to secure the SOLVENCY of the entire EU. Either way the Bavarian Burghers are going to bail out the peripheral countries through direct transfer payments and the financial repression of their bank accounts.

The problem for German politicians is that their citizens were never given a direct vote on the issue of being the paymaster for Europe. The U.S. is a single political entity with a unified taxing and supervisory authority. At this moment, Europe has no harmonized taxing or banking supervisory authority.The question remains for Draghi and the ECB–can they be successful in providing enough time for the EU economic recovery to take hold? Those buying the debt of all the peripherals at record low yields are placing a large wager on the ultimate SOLVENCY of the EU. As was widely reported today, Spanish 10-year yields were LOWER then the equivalent ten year U.S. note. Buying Spanish debt at 2.6% is not an investment for those with fears about the long-term prognosis of the EU.

The recent move of the ECB to push reserve rates into negative territory has just meant that European banks will keep buying sovereign debt as a way to avoid the ECB‘s penalty. Remember that according to Basel II rules, sovereign debt is considered a zero risk-weighted asset. It is good collateral and requires no holdback of reserves so all roads lead to Roman BONDS.

I am going to post the entire piece by Bloomberg reporter, Alexandra Harris, on the possible outcomes of the ECB‘s negative rate policy. It is a very solid summation and I am proud she is  my daughter. Enjoy.

(BFW) Banks May Keep Excess Cash at ECB in Spite of Negative Rate: JPM

By Alexandra Harris
June 9 (Bloomberg) — Bank access to high quality liquid
assets denominated in home currency is “central” to liquidity
management and financial stability, JPMorgan strategists Alex
Roever, Teresa Ho and John Iborg write in weekly note.
* Could be some shift in funds to Fed from ECB, volumes won’t
be “overwhelming”
* Balances in ECB facilities have been declining since
mid-2012, “roughly corresponding” to time ECB cut deposit
rate to 0% from 0.2%
* LTRO repayments contributing to shrinking ECB balance sheet;
repayments also “consumed some cash held at the ECB”
* IOER has already been “relatively attractive” to European
banks for past two years
* Not ECB’s intent to shift excess cash to Fed; central bank
is trying to spur investment in Europe
* “If the outcome it intends is not the outcome it gets,
we suspect this ECB would make further changes”

 

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2 Responses to “Notes From Underground: Financial Repression, European Style”

  1. Ronald Ferrill Says:

    one of your best, sir. Sometimes it is necessary to view the folly of others in order to understand our own. Were it just folly, this could be a message of only sly humor, instead of cynical premonition.

  2. kevinwaspi Says:

    Mr.Bernanke & Ms. Yellen,
    True, savers are not uni-dimensional, nor are they uni-habitual, then can be “retrained”. Unfortunately, this retraining has the distinct possibility of pushing the low savings rate and investable capital to even lower levels in the U.S. resulting in a less competitive economy in an already over-levered, internationally financed circumstance. The “saving grace” for Japan’s ability to carry the huge debt/gdp that it does is the huge domestic holding of JGBs. I doubt the global capital markets will grant the same graces to the U.S. when the entitlement spending pushes us again to a huger user of “social capital” long-term. Seven years now of ZIRP has not made me feel any “wealthier”, only “comfortably numb”.
    Roger Waters

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