Tuesday, June 7, 2011

From "golden fetters" to handcuffed investors

"The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves." - Alan Greenspan, 1966

An NBER working paper by Carmen Reinhart and Belen Sbrancia describes how Western governments in the post-world war economies unloaded their debts on credulous citizens through a policy of financial repression.  Because it is politically palatable (as opposed to outright default, hyperinflation, or overt tax increases) some analysts expect governments to try it again.  One part of it - inflation - is already well-underway.  Financial repression means savers (investors) will be forced to pay leviathan's debts, whether they like it or not.

The particulars of financial repression vary, but the general scheme is this: Using its power to violate private property rights, the government makes the domestic investment community a "captive audience."  With central bank cooperation it mandates low nominal interest rates along with a higher inflation rate, resulting in negative real interest rates.  The latter transfers wealth from, say, pension funds to the government, thus liquidating a portion of its debt.  Since the bond holders are "captive," there is no ready remedy for investors wishing to preserve or grow their wealth.  If investors attempt an alternative such as purchasing physical precious metals, the government will either restrict those activities or abolish them.  One way or another it will see that it has the "captives" needed to pay its bills.

The working paper contains language suggesting the authors have accepted several monetary fallacies.  For example, we read:
It is important to stress that during the period after WWI the gold standard was still in place in many countries, which meant that monetary policy was subordinated to keep a given gold parity. In those cases, inflation was not a policy variable available to policymakers in the same way that it was after the adoption of fiat currencies.
The post-WWI gold standard was a straw version of the classical gold standard, which itself was under government control.  Yet it's true, holders of Federal Reserve Notes could, in theory, swap them for gold coins prior to Roosevelt's heist in 1933.  "Monetary policy" (inflation) was indeed subordinated to gold, which is why government got rid of it, and the government-spawned gold-exchange standard of the 1920s served to set up gold, intentionally or not, to take the fall when the roof collapsed.  As economist Joesph Salerno writes,
The end of the classical liberal era in 1914 caused the removal from government central banks of the "golden handcuffs" of the genuine gold standard. Were these "golden handcuffs" still in place in the 1920’s, central banks would have been rigidly constrained from inflating their money supplies in the first place and the business cycle that culminated in the Great Depression would not have taken place.
The fractional-reserve scheme began to cave, as it always had, when too many people attempted to claim their property at the same time.  It exposed the essential fraud of the banking system, though few economists see it that way.  Which is not surprising, given that most of them, directly or indirectly, feed at the Fed's trough.

In another section of the NBER paper, Reinhart and Sbrancia tell us,
World War I and the suspension of convertibility and international gold shipments it brought, and, more generally, a variety of restrictions on cross border transactions were the first blows to the globalization of capital. Global capital markets recovered partially
during the roaring twenties, but the Great Depression, followed by World War II, put the final nails in the coffin of laissez faire banking.
This is truly shameful scholarship.  Banking was in no sense "laissez-faire."  The Federal Reserve Act of 1913, establishing a government-enforced banking cartel, erased the last traces of freedom in banking.  As we read in Wikipedia,
[Laissez faire] describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies.
The Fed is a monopoly money producer established by the state.  As such it is in violation of capitalism's private property foundation, and its very presence creates distortions in market activities.  (See The Ethics of Money Production, p. 170)  It seems that the further we move away from laissez-faire the more it is blamed for the catastrophes that follow in interventionism's wake.

Still, the NBER paper has great value.  The authors (rather tediously) document how Western governments from 1945-1980 used repressive financial schemes to pay down their debt relative to GDP.   The great appeal of such schemes is their transparency to the general public, making them virtually irresistible to today's debt-choked governments.

Reinhart and Rogoff's This Time is Different: Eight Centuries of Financial Folly spells it out this way:
Under financial repression, banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payment system. Governments force local residents to save in banks by giving them few, if any, other options. They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form of taxation. Citizens put money into banks because there are few other safe places for their savings. Governments, in turn, pass regulations and restrictions to force the banks to relend the money to fund public debt. (from Prudent Investor Newsletters) (emphasis mine)
It's an effective racket, almost as effective as the central banking - debt monetization schemes that brought us to disaster's door in the first place.


pipe said...

Jim Rickards was recently interviewed by King World News, and this topic was the basis for most of the interview. Rickards thinks they will try to implement this 'repression' angle, but he doesn't think it will work. However, one of Rickards' principal objections was that the fed won't be able to generate enough inflation to make it work. I wonder where Rickards is buying his gasoline, lol.

George said...

Bernanke has shown he has no reservations about putting the pedal to the metal. Thanks for the laugh about Richards and his source of gasoline.

Vincent Cate said...

Since most government spending during WWII was for the war, it was easy to cut government sending after the war ended. Today there is no easy way to make big cuts in government spending, so the same debt level is far more dangerous.

The State Unmasked

“So things aren't quite adding up the way they used to, huh? Some of your myths are a little shaky these days.” “My myths ? They're...