Financial repression – forcing investors to buy sovereign debt at real yields that are low or negative – is attractive to governments which have botched their finances. It also appeals to my colleague, Edward Hadas. But, the practice distorts the price mechanism and zaps the economy. The UK in the 1970s is a prime example – all pain, no gain for the economy. And, such repression is nothing more or less than theft from the most virtuous citizens — those who save.
The practice was standard after World War II, when governments which had built up huge debts wished to reduce debt and minimise the cost of servicing it. In the UK, the debt-to-GDP ratio reached 238 per cent in 1947. The government held interest rates close to or below inflation and used exchange controls to prevent domestic investors from moving money overseas. The ratio fell to 42 per cent of GDP in 1980 and the government financed an expensive welfare state.
The losers were savers, the trusting souls who believed, based on pre-war experience, that the government would not permanently debauch the currency. A war loan bought in 1947 lost 90 per cent of its real value by 1974.
Even with such high debt, repression was not essential. Lord Liverpool’s government reduced a similar debt load after the Napoleonic wars, while returning to the gold standard. He used virtue, not vice. The tools were careful management of the government and policies which promoted growth in the economy.
Governments today (except for Japan) are less indebted than the UK after its wars, and their debt problems are due to simple fiscal mismanagement. Two wrongs do not make a right. Financial repression destroys the nation’s savings base, discouraging new saving. That reduces long-term economic welfare.
The reason: Private savings – not government schemes or gold-plated financial manipulation – are the principal capital source for new business formation. Financial repression steals from the most productive to give to the government, the least productive economic sector. If implemented, it should be met by capital flight, even open rebellion.
