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It’s been puzzling me since the start of the financial crisis: why can incontinent governments like, say, the UK’s, borrow almost unlimited amounts at interest rates far below inflation? Stephen King at HSBC has been thinking about this, and has come up with a suitably apocalyptic (he has a reputation to defend, after all) explanation for the silly prices of government debt.
Rather than addressing the problem of too much of it, he points out that governments across the West are instead finding ways to force it down the buyers’ throats regardless of the price. Sadly for the struggling members of the eurozone, they can’t pull off this trick because they don’t control their domestic currency, but the proud printers of other major currencies are pulling it off like mad.
King calls this process financial repression, and now he comes to mention it, it’s clearly been going on for some time if you know where to look. The most obvious place is in the pensions industry. Normal investors tend to sell, or at least hold off when the price goes up, but for pension funds the opposite is true. A higher price means a lower yield, and a lower yield means that their future liabilities are greater in today’s money. So the higher the price of government stocks, the more they buy.
Much of the work needed to rig this market has been done, unwittingly, by the accountants and actuaries, in the name of financial transparency and liability matching. Government has helped by creating the Pensions Regulator, who has just ruled that fund liabilities must be calculated using today’s artificially depressed gilt yields. The result is that a further £100bn which would have helped companies survive long enough to pay pension promises is instead forced into their pension funds, and hence to the exchequer.
Even this army of forced buyers is not enough to provide all the cash the government needs to fund its £2bn-a-day spending habit, but reinforcements are on the way, in the shape of new reserving requirements for the banks. In future they will have to hold more “risk-free” assets, which in practice means holding more Govvies. Once again, others have done the state’s dirty work. The idea that holding a government stock is risk-free is a cruel joke for anyone whose memory goes back more than a couple of decades.
So King’s overt financial repression has hardly been necessary yet. We have it, in a mild form, with the tax privileges for some National Savings products, but if the pension funds and the banks cannot provide the cash, there are more radical approaches. Post-war credits allowed a desperate administration to raise yet more money while pretending that it wasn’t raising taxes even further. By the time the credits were repaid, they’d barely wrap a toffee.
The heavy weaponry is, of course, quantitative easing. As King points out, QE allows government to escape the disciplines associated with market forces by pushing bond yields down to low levels even when fiscal policy is out of control. The Bond Vigilantes at M&G have even made the heretical suggestion that the Bank of England should simply shred the vast portfolio of gilts it has accumulated under QE. The National Debt would be cut by a third and the Budget deficit would look eminently manageable. What’s not to like?
Carried to its logical extreme, the government would simply add to the existing stock of irredeemable, zero-coupon paper already in issue. They’re called banknotes. It could then appoint Robert Mugabe as the next Bank Governor, since he has relevant experience in this field. Long before hyperinflation is reached, the damage would be severe. Thanks to their forced purchases of gilts, pension funds are already well on the way to becoming as dependent on government promises as, say, the unfunded civil service scheme. The cost is financial starvation for the the productive sector of the economy .
The requirement for the banks to shrink their balance sheets to comply with the new reserve rules cuts the amount available to lend to businesses and individuals, and if that is not enough, limits on loan-to-value ratios and similar constraints make fund-raising more difficult. Borrowing costs for the UK government may be absurdly low, but the premium that households must pay for money is higher than for many years. The growth of peer-to-peer lending is a symptom of this financial repression, but it is far too small to have an impact on the economy.
The last time governments were as indebted as they are today, half a century ago, the burden was reduced by an unprecedented period of economic growth, coupled with a reluctance or inability to curb inflation. It’s possible that the emerging economies will pull the West into growing at a respectable speed, but it seems highly unlikely. Slow, or non-existent, economic growth is the way to bet, and coupled with ever-rising financial demands on the state, makes repression the least unpalatable option for the politicians in charge. And choosing the least unpalatable option, regardless of the long-run consequences, is what politicians of all colours tend to do.
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