the US political system has been unwilling to restructure big spending programs like Medicare and Social Security; a large-scale restructuring or default on US debt seems like a highly unlikely last resort; and US inflation has been stuck at low levels for 25 years now, for reasons not fully understood. Thus, I suspect the US economy may be headed, by fits and starts, to a period of what Reinhart and Sbrancia call “financial repression.” By this term, they mean a set of policies that invole much greater government management of the financial sector, including policies that focus on keeping interest rates very low and also limit other options available to investors–so that the government will find it easier to keep borrowing at low interest rates.
Financial repression means that government dictates how people save, essentially forcing them to finance government debt at artificially low rates. I can see doing this in a backward country that lacks financial markets that would allow people to get better interest rates than they can from the government. I cannot see how this would work in the United States. I think that we will get inflation instead.
Right now, people are bidding up the prices of assets, especially in the stock market. I think of an asset boom as deferred inflation. Eventually, people will sell assets and buy goods and services, and that is when we will see the inflation.
We already have a soft form of financial repression through asset risk-weighting for financial institution capital standards. Government debt and government-backed debt (like loan guarantees) can be financed 100% with debt, so with no capital. Privileging government debt just a little bit more than government-backed debt is one option. Another could be privileging government debt in stress tests and other regulatory exercises. Finally, new payments systems like Libra could be required to back their operations with Treasuries. It seems like many possibilities exist.
I agree with Kurt. I think there is already a heavy dose of financial repression baked into U.S. asset prices. A few things to consider:
1. Financial markets are global. In my humble opinion, degrees of financial repression have existed for years in capital markets in places such as China, and to a lesser extent Europe. Because of the semi-globalization of financial markets, sooner or later this repression gets exported to other countries. Central banks are complicit in this.
2. Financial repression and inflation need not be mutually exclusive. In fact, I think they often occur together. If a country’s citizens experience high consumer price inflation, but get lousy returns on investments, they are probably the victim of financial repression. Think China, Russia, Venezuela.
3. I agree with Arnold’s analysis of the link between asset price inflation and CPI (i.e., consumer price inflation) in that the former may lead the latter. I had never thought of it that way before. But now that I’ve been introduced to the idea, I think this is a clever incite from Mr. Kling.
Financial markets have always been “repressed”, that is, the target of government intervention. The reason is very simple: governments have a long history of plundering to finance the rulers’ expensive life-styles and more importantly to guard their power against their enemies and to expand it by destroying their enemies. The construction of each political jurisdiction has been the project of an ambitious power-seeker and the projects have to be financed. When plundering was not sufficient, they rely on lenders who were willing to be extorted to protect their business with private borrowers. Yes, today government borrowing from lenders may seem to be a regular business but just think what would happen in each country –each with its particular system of government– if the ruler needs some additional funds and cannot rely on taxation (if you want to entertain yourself with this issue read Argentina’s press every day, starting today, and you will learn what such ruler may do with the advice of great economists –the incumbent prefers Joe Stiglitz’s).
Aren’t Chinese peasants essentially forced to save in securities that ultimately finance US deficits at extremely low interest rates. Aren’t Chinese elites trying to skirt that fact why world city real estate and Macau have exploded.
Like everything else, didn’t we outsource our financial oppression.
1) I’m thinking that peasants, pretty much by definition, have very little in the way of savings. And, to extent that they do, they are savvy enough to retain such savings in gold under black market transactions. This is basically how it works in the developing world.
2) as far as I can tell, no one in China, including the government, was forced to buy our debt. They willingly did it and in exchange we got cool consumer goods. Why they chose to voluntarily accept these terms is an unsolved mystery in my ignorant mind.
1) The Chinese Savings rate is 47%.
2) People in China are forced to invest their savings in certain ways that are used by the government of China to fund our debt. While it’s true that the government of China isn’t forced to do this, its people certainly are.
1) if the peasants have a savings rate of 47%, then they probably aren’t peasants. How many businesses do you know with a 47% profit margin (which is precisely what savings implies)?
2) again, the unsolved mystery to me: why did the Chinese government voluntarily accept these terms? Seems like financial suicide to me since all of the debt is non-recourse and it’s not like they can send over guys with baseball bats to collect.
3) perhaps you should consider opening a hot dog stand over there instead? You seemed to have a pretty good grasp of the licensing fees and related economics involved. Or, maybe a banana stand?
1) Semantics. The household sector is the driver on the savings rate.
2) Trade surplus driven industrial development has been the blueprint for East Asian tigers for a long time. It worked for China too, in the broad sense.
I agree that their population size and lateness to the party make it much harder for them to follow the script than it was for Japan.
Beyond that, once these export tycoons were getting rich there was an interest group pretty wedded to this state of affairs continuing, and elites rarely like painful and uncertain adjustments to something that is working well enough. In the long run, they are all dead.
In some sense, I mean that literally. None of these Asian countries had enough kids. If they saved domestically, where would it go? They have no future human beings to invest IN. Just a lot of empty apartment buildings.
The fact that there is no next generation of productive people to create the future savers hope to consume is a big problem.
3) Seems like the Han don’t let foreigners control any truly profitable domestic industry for long.
The connection between consumer inflation and asset inflation might be the least understood area of modern economics. I don’t claim to understand it but my intuitions about it are as follows:
The stock market crashes in 2000 and 2008 did not result in deferred inflation. Not even a little. Asset prices are prone to crashes in a way that consumer prices are not since a much smaller percentage of them are being traded at any given time and it is only those trades that set prices. Also demand for consumer products is more consistent than demand for financial assets. I think of the prices of financial assets as a layer of ice on a body of water. That ice usually feels reliable but might break unexpectedly at any time. When too many investors try to exit at the same time they find out those financial assets didn’t translate in aggregate to nearly the amount of tangible goods and services it had appeared they did.
There is a worldwide safe asset shortage. Our most profitable companies used to be big industrial companies that borrowed a lot of money to expand operations. That provided a supply of safe assets that has been sharply reduced. Today our most profitable companies tend to be tech companies that are stockpiling cash and looking to invest it in ways that further fuel asset inflation.
Also increasing levels of inequality in financial wealth are driving the inflation of financial assets and limiting inflation in consumer goods and services.
I believe that demographics is also an under appreciated factor in all of this. Growing populations mean growing markets in a way that tends to fuel consumer inflation. Shrinking populations make it difficult to support economic growth and inflation.
I think you are right that the government would resort to financial repression if it needed to but I’m not convinced we are near the place (going past the “second floor”) where it will need to soon. U.S. government debt still pays higher market interest rates than comparable government that are less safe.
The one thing that could upend all this and result in consumer inflation is a big supply shock like a war, depression, or natural disaster.
Arnold, I was 8 years old when Perón introduced the “mother of all financial repression”. He imposed a 100% reserve requirement on ALL bank deposits and the Central Bank was given the power to allocate the funds by following government instructions. It lasted until 1957, and in those 8 years, the government could see how the total amount of deposits declined (I don’t have time to search the data). It had to revive the old idea of the Postal System of Savings (in the school we were encouraged to save in this system for our glorious future) but it was not enough because savings were intermediated through informal markets and/or invested in U.S. dollars. Remember that at that time, the payments system was still centered on currency for small payments and paper orders (checks) on demand deposits for large payments.
Since 1957, Argentina has tried all types of regulations on the banking system but –even today, at this very moment– the regulations have not been enough to prevent banking, and foreign-exchange crises. Thus, exceptional interventions have been necessary (as it happened last Monday, just a couple of months after reaching an agreement to renegotiate the government’s foreign debt). The ultimate cause of all crises has been and still is the failure to eliminate the fiscal deficit. The prospects are as bad as in the worse times of the past 70 years because of strong pressures in increasing government expenditures at a time in which any attempt to increase taxation will fail to increase revenue.
Yes, financial repression will not be a solution to the U.S. fiscal problem. At some point (the sooner the better, exactly what politicians don’t want to hear), the government will have to renegotiate its debt with bondholders but success depends on compliance with the conditionality agreed with them. If the first renegotiation fails, welcome to Argentina’s way of life.
For policy that would “limit other options available to investors” look no further than the Biden tax plan. The Tax Foundation estimates that it would shrink capital stock by 3.23 percent.
How would investment opportunity be limited?
First, Biden has vowed to eliminate tax deductions for 401(k) contributions in the name of “Equalizing the tax benefits of defined contribution plans.”
Second, Biden has vowed to tax capital gains at rates up to 39.6 percent which would be the new top income tax rate. Step up in basis would be eliminated.
Not that anyone should expect any such gains. Thirdly, the corporate income tax rate would be increased back to 28 percent. And there would be a new 15 percent alternative minimum tax on corporations with book profits of $100 million or higher. And Biden would double the tax rate on Global Intangible Low Tax Income earned by foreign subsidiaries of US firms from 10.5 percent to 21 percent.
“According to the Tax Foundation General Equilibrium Model, Biden’s tax plan would reduce the economy’s size by 1.51 percent in the long run. The plan would shrink the capital stock by 3.23 percent and reduce the overall wage rate by 0.98 percent, leading to 585,000 fewer full-time equivalent jobs.”
https://taxfoundation.org/joe-biden-tax-plan-2020/
I’d say it’s more like 1.5234%, why not? These forecasts are idiotic.
Models are models and false precision is inescapable, So, yes, false precision is idiotic, especially in complex systems like economies and the climate.
Nevertheless, they sometimes give us an idea about what to expect. In this case, I’d bet $100 that not one year of the Biden-Harris regime will produce results that top 2018- 2019’s median household income increase of 6.8 percent to $68,703 between 2018 and 2019, a full-time wages in the middle of the national wage scale growing by an average of 2.1% to $57,456, median full-time female employees wages gaining 2.5%, up to $47,299, and household income growth for Latino households of 7.1%; black households of 7.9%; and Asian households 10.6%. And a decrease of 1.3 percentage points from 11.8% in 2018 10.5% in 2019 in the poverty rate. All figures from https://www.census.gov/library/publications/2020/demo/p60-270.html
The beautiful thing about submitting to a flawed and corrupt electoral process is that you get what you deserve, good and hard.
Regarding foreign purchases of USA debt, although China has been cutting their US debt holdings: “China cut its US Treasury bond holdings by $1 billion in July to $1.07 trillion, US Treasury Department data showed Wednesday.” https://www.globaltimes.cn/content/1201194.shtml
Other foreigners have taken up the slack: “Foreign holdings of U.S. Treasuries grew for a third straight month in July, data from the Treasury department showed on Wednesday, as investors snapped up U.S. debt in a world of negative-yielding bonds.
Overseas investors held $7.087 trillion in U.S. Treasuries in July, from $7.039 trillion the previous month.”
and
“Japan remained the largest non-U.S. holder of Treasuries during the month, ahead of China, with Japanese holdings rising to $1.293 trillion in July, from $1.262 trillion in June.”
https://www.reuters.com/article/usa-treasury-securities-idUSL1N2GD2FR
The other attack on investment opportunity is the wokester/libertarian Yes In Your Backyard alliance devoted to destroying homeowners’ equity using the Biden plan to replace local zoning protection for home values with federal government control. The average net worth for a homeowner is $1,034,200 versus only $91,100 for a renter. When every neighborhood has been converted into a slum, this difference should be equalized. Real estate will be eliminated as an attractive non-financial investment asset.
The war on the suburbs is perhaps the worst form of financial repression.
YIMBYs don’t want to build in the suburbs they want to build in cities. Removing the Soviet approval system from building is not going to cause a precipitous drop in home prices though it may stop their artificial ascent. Ending the building vetocracy and restoring property rights won’t stop people from buying homes, it will allow more people to buy homes.
What people pay for when they buy a house in a nice neighborhood is, in large part, the privilege of not having dysfunctional neighbors and (if they have kids) having public schools where the kids actually learn something. Take that away and, yes, the value of the housing in that neighborhood is going to decline.
Of course, this probably wont’ affect the posh neighborhoods of people as wealthy as the Bidens and and the real estate industry fat cats who are licking their chops at the prospect of building the new “affordable” housing in middle class suburbs (and presumably funding the absurd “libertarian” propaganda pushing this scheme).
A lot of zoning policies and NIMBY rationalizations come about as coping mechanisms in the attempt to avoid the fallout from three generations of urban insanity. People can’t be forthright about their honest and legitimate concerns so they come up with some baloney instead that is socially accepted as an excuse.
Unfortunately, any regulatory institution able to give people the one thing they need in this area is also going to give them 100 other unjustifiably terrible policies.
Libertarians are often completely correct in their criticism of those 100 terrible things. But that misses the point. Those are the bathwater, and if you throw them out, you will also toss the baby. It just so happens the baby is sitting in a bunch of sewage, but as much as you might want to get rid of sewage, if someone tells you “just dump the tub”, they are either being clueless or callous about your baby.
Actually there is another legitimate basis for NIMBYism that people actually can discuss openly, and so talk your ears off about it every chance they get: congestion.
My proposal is “preservation of infrastructural adequacy”. Build what you want, but the builder has to pitch in for what it takes to construct their contribution to additional needs for road lanes and maintenance and transit, and those things have to be completed and exist before anyone can move in.
My guess is that a lot of new housing proposed for already congested areas would become suddenly uneconomical with just this one requirement. The reason the housing looks potentially cheap on paper is because the current legal convention is that they don’t have to compensate neighbors for loss of their quality of life and value of their properties resulting from density-upgrade externalities.
The “libertarian” angle on this issue is baloney. The Democrats are not talking about ending real property regulation generally but specifically about ending zoning that keeps high density low-income housing out of the suburbs. And that housing, when it goes up, will be government-subsidized. Does anyone doubt that the libertarian groups touting this initiative (even if the writers themselves are sincere) are financially connected with the cynical real estate and construction interests that stand to benefit?
This works the same way in post-Soviet cities where residential condo developers are not obliged (practically speaking) to provide infrastructure. In contrast to America however, there is little to stop them from building more and more units. Residents of nearby buildings sometimes make a fuss, but their success rate isn’t high, and if it comes to litigation developers always have more money. As a result big cities become progressively more congested with cars and condos. Russians call it ‘point development’ and ‘fill-in development’. Only Moscow, the richest city among these by an order of magnitude, has managed to stop the plague after a run of some 20 years. Moscow former mayor Luzhkov’s wife used to run a big construction conglomerate.
You must have different YIMBYs. They are all over the suburbs where I’m from.
Suburbs have “good schools” which have something like a $300k value to a family with two kids. The average home in the USA is worth $240k, an even affluent suburban counties near world cities average $400-$500k. So zoning is worth half or more of peoples housing value based solely on the school district.
Neighborhood environment is a commons. Elinor Ostrom won the Econ Nobel for demonstrating local regulation of commons produces better outcomes than remote no-skin-in-the-game regulation.
The true Soviet features of YIYBY are all the federal government social engineering that goes with it: the neo-apartheid “Affirmatively Furthering Fair Housing Rule” in which the federal government dictates the permissible racial composition of neighborhoods, subsidies to develop equity-destroying low-income housing developments in existing communities, outlawing single family residential, and adding more section 8 vouchers to relocate the poor from convenient downtown locations to subsidize gentrification.
If private property had anything to do with YIYBY the first target in California would not have been to ban homeowners associations from privately building and creating single family residential neighborhoods. Incidentally research has shown that Dallas with local zoning has neighbored racial integration demographics similar to famously no-zoning Houston.
YIYB has made a priority of diminishing the value of the nation’s housing stock whether out of useful idiot libertarianism or for purely Marxist antipathy to private wealth. The only person you are fooling with your irrelevant claptrap about private property is yourself.
Arnold, if people sell assets en-mass, wouldn’t that cause a bust that would drop the prices of those assets, removing the gains to be spend elsewhere? Happy to be wrong on this.
The demographic pig is making its way through the python now. Vanguard, Blackrock, etc (abetted by government policy) are now indiscriminately bidding up stock prices because they’re still in accumulation mode on behalf of the boomers. Once they’re forced to liquidate to pay for the boomers’ retirements, and the funds from younger generations aren’t sufficient to generate net accumulation, stock prices will have to fall. Passive investing will end up destroying itself.
How many people in the world can invest in stocks listed on US exchanges?
Lots. So what?
Todd, I’m not sure I understand your point. Retirement accounts from Vanguard are constantly liquidating as boomers reach the age when they can draw from them. It’s a continuous process, not a cliff. The boomer generation will not retire all at once.
But think about the generational flows. How big and wealthy is the cohort following the baby boomers? Not nearly as big, not nearly as wealthy. Therefore, there won’t be the magnitude of flows into the markets to support the indiscriminate buying that passive investing now engages in. The current/near term pricing of stock market assets is and will be misaligned with the buying power of future generations. (Think of the imbalance in the flows associated with Social Security.) As with welfare-state finances generally, the problem here is going to be few people, not too many people.
Passive investing has its place, but when it becomes too pervasive, it becomes highly problematic.
There are charts out there showing real interest rates falling for centuries, even more.
I suspect this is as people and societies become more advanced, the ability to save is enhanced. We are not living hand to mouth anymore. Capital is no longer scarce, and never will be again Sorry to say, your capital is just not that valuable anymore, nor mine either.
This may feel like “financial repression.”
So, inflation? Maybe so, and mild inflation is hardly a tragedy. In fact, many nations have exhibited more-robust real growth in periods of moderate inflation, than in lower rates of inflation.
The other riddle is that the US and its central bank are not the world. We live in a world of globalized asset markets, perhaps $400 trillion in bonds, equities, property, and who knows how much more in other assets.
So the US government issues a few trillion dollars in bonds, and then pays off the bonds in freshly printed cash. It is unfair in some regards, but doing so is like pouring a cup of water into a pond.
You are wrong. Capital is still scarce and it will always be scarce. Just try to get financing for your new project. Although today many people have more alternative sources of capital for financing their projects, none of them are free. Housing is the best example. As a result of the large increase in savings intermediated by banks and others, today many people can borrow to buy a house but is not free. Just yesterday, in Santiago Chile, I figured out that to buy an apartment as an investment you can expect an annual return of at most 5%, and if you borrow the funds to buy it (meeting some conditions that no many people can) the interest rate on a good mortgage will be at least 4%.
Yes, we live in a rich world, one in which people save and invest as much as ever. But capital is still scarce.
The implication for governments is that they can rely on borrowing for financing deficits rather than on the inflation tax. Again, if you want to know how it works you should study how successive Argentinian governments have been financing their expenditures since the end of WWII. Despite the several overtures of foreign lenders after every fiscal crisis of the past 70 years, the government has continued to have problems to finance its increasing expenditures. Argentina’s hyperinflations of the 1980s (exactly, the several episodes between July 1982 and March 1991) were the result of borrowing too much while continue increasing expenditures. Since 1991, however, successive governments have been afraid of the consequences of hyperinflation and avoided that extreme. They know that capital is scarce, in particular, for governments with a terrible record (the funny thing is that now the dying IMF is trying to continue open by funding the Argentinian government).
I think we underestimate the degree to which Social Security and Medicare can be restructured/reformed *in the future*. It seems politically impossible now because Boomers are the main recipients. In the future, Gen Xers (of which I am one) will be the retirees, and Millennials and Gen Zers will be the taxpayers. Consider:
(1) Millennials outnumber Gen X and are more politically active.
(2) History means nothing to Millennials and Gen Z. They have forgotten/ignored almost every lesson of the 20th Century, and they will just as easily cut Gen X retirement benefits no matter how much Gen Xers try to argue that they have already paid for such benefits with past taxes.
(3) More than any previous generation, Gen Xers think of their retirement planning in terms of IRAs and 401(k)s rather than Social Security. Many Gen Xers have already resigned themselves to believing that Social Security won’t be there for them. We have been told our entire adult lives that Social Security is on a path to insolvency.
(4) Gen X is a very conservative generation. Even as young adults in the 80s and 90s, Gen X was more conservative than their parents — very rare. Part of that conservatism is antipathy towards Social Security.
Put that all together, and it seems like the most likely outcome will be that, when Gen X starts retiring, Social Security will phase in means-tested benefits. Poor Gen Xers will receive some benefits, but more affluent Gen Xers will be expected to live off their retirement savings. Social Security will become just another welfare program for the poor.
Maybe, but irrelevant.
The big cash cow is Medicare. Always has been. Healthcare costs are what will bankrupt us, and they have a huge lobby behind them. Those Millenials with nursing degrees aren’t going to want to get laid off in Medicare cuts.
More and more of the available labor pool of the next generation will go into healthcare trying to suck one more miserable nursing home year out of the old.
Jim Grant on QE and inflation:
“What I missed in 2011 was the technical fact that the dollar bills that the Fed was creating effortlessly were not in circulation in the broad economy . . . but were locked up in the reserve accounts of the banks at the Federal Reserve system.”
On June 14, 1985, the Argentinian government announced a new stabilization plan to stop the ongoing hyperinflation. It was based on a new currency, the Austral, and a new promise, not to issue more money (it didn’t explain the details of how the deficit was going to be eliminated and financed in the transition). Guess what? The Central Bank (in Argentina the unit responsible for issuing currency) had already issued a lot of money in the previous few days and locked it up at the Banco de la Nación, the large commercial bank owned by the Federal Government). Surprise: the government used the money stored in Banco de la Nación.
To make things even more grotesque, that stabilization plan relied on a complicated scheme to get rid of inflation clauses in private contracts (after decades of high inflation they were popular because successive governments rejected the Chilean solution of a monetary unit that adjusted monthly by IPC, this is the famous Chilean UF whose origin is a recommendation by the great economist Lauchlin Currie –see Wikipedia entry– to Colombia’s government in the early 1950s).
I don’t follow Jim Grant (I know he writes a lot) but assuming that he’s serious about the currency being locked up, the relevant issue is how long it was locked it up before being used. In Argentina, it was a question of hours and days.