What is Financial Repression?
What I’ve learned in 2014-2015:
INTRODUCTIONLearning about financial repression is a little like discovering the truth about Santa Claus - once known, the world never looks quite the same again. To understand financial repression, we first have to properly understand inflation.
INFLATIONInflation is a concept that has been over simplified, and as a result few people understand how it works or why it happens. When people speak of inflation, they actually mean price inflation - a sustained rise in prices over a period of time - but price inflation is heavily influenced by, and often directly caused by, monetary inflation. This is rarely made clear.
Monetary inflation means an expansion of the national currency supply. When the supply of a currency is increased by the government, each unit of currency (a pound or dollar) loses some of its value.
To understand this clearly, we have to understand what money is, and how it differs to currency.
MONEY vs. CURRENCYWhen people work they spend time and energy to create economic value. Money is proof of this economic value and is used instead of barter to efficiently trade for goods and services.
Currency is a container that allows us to store and transport money between trades.
Here’s an easy way to picture how money and currency relate, and how inflation reduces the economic value (purchasing power) of currency:
1) Think of the value (money) as whisky, to be shared between five workers.
2) Think of the containers (currency) as five glasses on a table, one held by each worker.
3) Each of the glasses must always hold an equal amount of whisky (my dollar should hold the same value as your dollar).
Now picture the government, coming along with three more glasses to add to the table. The whisky must be recalculated between all eight glasses (otherwise my dollar doesn’t have the same value as your dollar). The government hasn’t worked for the whisky like the workers have, but they capture some of the whisky because they control the number of glasses. Now the workers have less whisky each - and less between them - and if they wanted to trade the whisky for other goods, they’d need more of it relative to the goods they want to buy.
This is why prices rise, as it takes a few more units of currency to purchase the same amount of goods. Things haven’t risen in value, our currency has simply been devalued relative to the goods we want to buy with it.
This effect of rising prices is what we commonly call inflation, but the rising prices are just a symptom of inflation and the resulting weakening of the currency.
WHY CAUSE INFLATION?Why would we have any need for inflation then? Why do prices always seem to go up - why do the size of chocolate bars always shrink?
Essentially, it comes down to how governments raise money. They do it by selling bonds to investors. These bond buyers expect a return for their investment, so they are paid interest on the bonds they buy. So when politicians promise things to get elected, they raise money to pay for it, and end up owing more debt to investors.
Sometimes this debt gets too high to comfortably pay back, as is the case now in the UK where the government has to service interest payments in excess of £1bn per week.
Remember that inflation reduces the value of the currency? Governments use this to make their debt payments easier to service: the same amount of economic effort in a high inflation environment provides more units of currency than when the borrowing occurred, so it’s easier to pay the interest due on the debt. However, if governments aren’t generating enough revenue from their assets and taxes to pay the debt, they have to continually borrow more currency to pay back the older debts. This is how debts spiral out of control.
Fortunately, there’s something else that governments can do...
FINANCIAL REPRESSIONFinancial repression allows governments to pay down their debt without raising taxes and subsequently upsetting lots of people. It’s far stealthier, and has been used by governments all across the developed world to manage huge debt repayment without many people understanding how it works.
It is done using two key ingredients that work together:
1) The first ingredient is creating a certain target inflation level. By printing money (Quantitative Easing or QE), governments can artificially create a higher level of inflation. Our government (and the US and collaboratively in the EU) is currently seeking an inflation target of 2%.
2) The second ingredient is controlling the interest rate to lower it. If the government lowers the interest rate to a sufficient level (we have never had an interest rate as low as we do now for as long as we have - since 2008), then the interest paid on savings is not keeping up with inflation.
In the case of a 2% inflation rate and an interest rate of 0.5%, you’re effectively getting a negative interest rate - or being taxed 1.5% every year on your savings and your wages.
The result is that purchasing power - the economic value you generate when you work - is slowly being eroded, and used to pay down government debt. It also means my beloved Snickers bar will continue shrinking :’(
Draw your own conclusions.
 The wikipedia definition of inflation isn’t very useful when trying to understand why it happens - you have to dig deeper into the history of the term. Perhaps it’s because the true meaning of the word has been lost, but there is a separate entry in wikipedia for monetary inflation. The Austrian school of economic theory makes no distinction between inflation and monetary inflation however: https://en.wikipedia.org/wiki/Austrian_School#Inflation
 Whilst this has worked in the past, it’s not working as expected currently, at least not in the way that governments are looking for. Inflation is not showing up in consumer prices yet, but it is in real estate and stock markets. There are countless theories about why this is the case, but eventually prices will rise, although not until the extra currency finds its way into the hands of consumers who are willing to spend it.