What is Financial Repression?

recurvrecurv Posts: 55 Copper ✭✭
edited December 2015 in Tips from Goldmoney Members
This is a an article I wrote to test my own understanding, and to share the knowledge as clearly and as simply as possible with friends. I know there are some super wise people in this community (Hi @GrandpaBrian!), so this will be way too simplistic for some readers, but please do point out any errors I've made if you spot some!

What I’ve learned in 2014-2015:

INTRODUCTION

Learning 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.

INFLATION

Inflation is a concept that has been over simplified[1], 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. CURRENCY

When 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 REPRESSION

Financial 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[2]. 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 :’(

Interesting, huh?

Draw your own conclusions.

--

[1] 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

[2] 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.

Comments

  • recurvrecurv Posts: 55 Copper ✭✭
    No comments or feedback anyone?
  • GLDGLD Posts: 49 Copper ✭✭
    edited December 2015
    recurv said:

    No comments or feedback anyone?

    Yes great article ..... and all points are accurate i believe, as a number of other writers i have read have described "the system" as such.

    My only argument would be about the ending comment, specifically the last sentence:

    ....." 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."

    I don't quite see how this causes the governments to "pay down debt" .... they could i suppose, but all i see year after year is larger debt numbers at every level of government.

    Anyway, once the city of Chicago and several state pension funds file for chapter 11, i think the whole global financial house of cards will start its "snowball run down the hill"!


    Graphic added for effect! ...lol
  • recurvrecurv Posts: 55 Copper ✭✭
    @GLD Indeed, the debt levels do seem to be going up indefinitely; perhaps they're not going up quite as fast as they could due to RF..?

    I'm barely afloat in this ocean of knowledge, but am educating myself at every opportunity.
  • rohanibuang61rohanibuang61 Posts: 2,379 Gold ✭✭✭✭✭
    @recurv , Awesome and appreciate your knowledge
  • recurvrecurv Posts: 55 Copper ✭✭
    Thanks for the comment @rohanibuang61, my Christmas Eve wasn't spent in vain :p
  • KimKim Posts: 636 Bronze ✭✭✭
    @recurv, I am just like you "educating myself at every opportunity". I am now super tuned in to things financial more than ever.
  • rohanibuang61rohanibuang61 Posts: 2,379 Gold ✭✭✭✭✭
    @recurv same to you and all the best.
  • RainmantexRainmantex Posts: 1 Tin ✭
    I will be the first to say I don't know much about money or else I would have a lot. It seems to me the federal reserve really prints money based on nothing. In reality the only reason the dollar has any value is because we as people accept it has value. By this I mean the dollar is not actually backed up by anything physical, like gold. So I guess my question is, am I looking at this right or is there something I don't understand. I hope it is the latter.
  • GoldIsCurrencyGoldIsCurrency Posts: 1,781 Gold ✭✭✭✭✭
    edited March 2016
    @Rainmantex You have it right, printing like ink is going out of style. My recommendation would be to read "Currency Wars" or "The Golden Revolution" or "The Money Bubble" which are a few of the books on this whole topic. Rickards also has a new book "The New Case for Gold" that was just released. Any of them will give you a clearer outlook on the fiat money circus also known as the 40 year experiment.

    Paper is paper and gold is gold.
  • MurphyMurphy Posts: 98 Bronze ✭✭✭
    The beauty of gold is it can cancel out debt. It will always keep the debt in the system to a manageable level. When money itself is debt which it is right now then new debt must always be issued. The credit in the system must continue to grow it can't be cancelled out only shifted. This will reach unsustainable levels and continually push down the real rate of interest. Sooner or later the system will become unmanageable and unsustainable. Monetary Metals is a good site to read also.
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