Overview
"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 deliberately and methodically stripping wealth (and therefore security and retirement lifestyle) 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. As we will explore in this article, the essence of Financial Repression is using a combination of inflation and government control of interest rates in an environment of capital controls to confiscate the value of the savings of the world's savers. Rephrased in less academic terms - 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 (in the postwar historical example), and it uses an assortment of carrots and sticks to make sure investors have no choice but to accept having the purchasing power of their investments shrink each 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 is what makes 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 Mechanics Of Financial Repression
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.