Financial repression has been unthinkable in western open capital markets - until now

Today’s combination of public sector deficit, higher interest rates and almost zero growth is potentially catastrophic.

via Ehud Neuhaus/ Unsplash

Financial repression is an ugly phrase to describe an ugly idea. It effectively forces savers to accept a return on their money below a market rate, allowing perennial borrowers to issue debt at a discount. Widely practised in third-world countries with incontinent governments, it has been unthinkable in the open capital markets of the West. Until now.

On both sides of the Atlantic, the gap between what an administration can raise in tax and what it spends is growing. This is nothing new. What is new is the size of the gaps, and the failure of the economies to grow fast enough to contain the cost of running the deficits. In the US, this has mattered less because Uncle Sam prints the world’s currency, issued as either irredeemable, interest-free loans (usually called banknotes) or sold as dollar-denominated debt.

Other countries are not so lucky. They must offer a higher return than the equivalent dollar debt to attract foreign capital, as with UK gilts, to compensate for the exchange rate risk. Today’s combination of public sector deficit, higher interest rates and almost zero growth is potentially catastrophic. If the administration is incapable of controlling its spending - as this one is demonstrating almost daily - then the yet higher taxes we are being softened up for become inevitable.

We then run into the problem of plucking ever more feathers from the complaining goose. We are discovering that the fattest geese are already feeling pretty plucked off, and are flying away to balmier financial climes. Rather than cook the ones that remain, a desperate government could resort to financial repression.

The banks always present a tempting target, since they are large, generally unpopular, and that’s where the money is. An edict limiting the interest rate they could pay on short-term savings, coupled with increasing reserve requirements would raise billions, perhaps tens of billions, of pounds. There would be no obvious consequences. The banks would have much less to lend, so some projects which might raise the already near-imperceptible growth rate of the UK economy.

The other obvious target is the pension funds, and Labour is already some way down this road, taking “reserve powers” (dread phrase) to force them to invest in British assets, if asking them nicely fails to get them to do so. The financial repression here is obvious: if the managers are barred from buying the asset they consider the best value they have a wonderful excuse for poor performance. This counts double if they are strong-armed into supporting an infrastructure project chosen by the government. The Lower Thames Crossing may be much needed, but it could easily turn into another HS2.

If things get really desperate for the government, there are always foreign exchange controls, special “voluntary” green bonds paying less than the market rate or a ban on holding assets like gold. None of these seems remotely likely today. But this is the direction of travel given the grisly state of the public finances that the Chancellor faces ahead of her spending review.