Kenneth Rogoff's 'Financial Repression'
Oct. 11, 2014 10:28 AM ET
Kenneth Rogoff and Carmen Reinhart (R&R) in a recent IMF paper entitled "Financial and Sovereign Debt Crises..." are back to their old trick of using emotional phraseology to try and scare us on the subject of national debts. They've been using the phrase "debt overhang" instead of the word "debt" for several years so as to persuade us we're beneath some sort of overhanging cliff which is about to collapse on our heads.
And their latest bit of emotional propaganda is the phrase "financial repression": that's the idea that some countries in the past have employed various draconian or dishonest measures to reduce debts like defaults or engineering excess inflation so as to cut the real value of the debt, therefore the same is likely happen again in the case of countries which currently have larger than normal debts.
In the above paper, they use the phrase "debt overhang" twelve times and the word "repression" twenty six times! Plus they allude vaguely to the "austerity" which is allegedly needed to pay down debts: they say, "Although austerity in varying degrees is necessary, in many cases it is not sufficient to cope with the sheer magnitude of public and private debt overhangs."
Well, just in case you're worried about all this, I'll attempt a more calm, collected and precise analysis of this near non-existent problem than R&R managed.
Why reduce the debt?
The first flaw in R&R's argument is that they don't tell us why, just because the debt is larger than normal, it needs to be reduced. After all, if the rate of interest paid on it is equal to or less than inflation, then the REAL RATE OF INTEREST (i.e. the inflation adjusted rate) is respectively zero or negative. And in the case of a negative real rate, the debtor profits at the expense of the creditor. In that case there is no problem for the debtor!
In fact, assuming interest on the debt is zero or near zero (which is about where it's been for several large countries for a few years now) it would actually be COUNTER PRODUCTIVE to dispose of the debt, and for a reason pointed out time and again by advocates of Modern Monetary Theory. That is that the debt and monetary base are ASSETS as viewed by the private sector. And if the private sector is not supplied with the quantity of assets that it wants, it will attempt to save so as to acquire those assets. But that leads to paradox of thrift unemployment!
The solution: quantitative easing
But let's assume that interest on the debt is too high, and that the debt needs to be reduced.
At the start of their section IV, R&R give a list of five possible ways of reducing the debt. They are (to quote):
1. Economic growth. 2. Fiscal adjustment-austerity. 3. Explicit (de jure) default or restructuring.4. Inflation surprise. 5. A steady dose of financial repression accompanied by a steady dose of inflation.
They say that economic growth is unlikely to contribute much (despite the fact that growth in the two decades after WWII contributed a lot to reducing the big debt / GDP ratio that WWII caused). So that leaves four "nasty" solutions.
But they've missed out a near painless way of reducing the debt which about 99% of the population, the mentally retarded included, is by now all aware of: QUANTITATIVE EASING!!!!
QE involves having the central bank create new money out of thin air and buy up sundry private sector held assets (almost exclusively government debt in the case of the UK).
Of course that debt is still theoretically in existence: it's the property of the central bank. So the Treasury owes the central bank megabucks. But the central bank's profits are remitted to the Treasury at the end of every year. So if that debt is simply torn up, there's no effect on the real economy.
Inflation
Of course printing new money and buying up government debt might be inflationary, though QE has not in practice proved all that inflationary. But to the extent that IT IS INFLATIONARY, that's easily countered by raising taxes and "unprinting" the money collected (and/or cutting public spending).
Note that as long as the latter inflationary effect equals the DEFLATONARY effect of the "unprinting", there is no effect on GDP, numbers employed, etc. Where's the "repression" there?
You could of course count the latter raised taxes as "repression". But if you do, then we've endured tens of billions of dollars / pounds worth of "repression" (aka taxes) every year for the last two centuries or so. Somehow we've survived to tell the tale. Moreover, 99% of the population is perfectly comfortable with the fact that taxes have to be collected, first to pay for public spending, and second to adjust demand.
Money owed to foreigners
Having just said that the QE method of cutting the debt has no effect on GDP, numbers employed, etc., there is an exception to that rule: where a significant portion of the debt is held by foreigners.
R&R do refer to the distinction between debt owed to natives of a country and debt owed to foreigners, but they do not explain the exact relevance of that distinction. Perhaps I can help.
If foreigners are given zero interest yielding base money in exchange for their government debt as part of QE, obviously some of them will take their money elsewhere in the world in search of better yield. And that will depress the value of the currency of the country doing the QE on foreign exchange markets. And that means a cut in living standards for citizens of the country concerned (though there is no good reason for unemployment to rise).
However, it is inevitable that when a country borrows from abroad it enjoys a temporary standard of living boost, and when it repays the money, it endures a temporary standard of living cut. That's no different to a household which enjoys a temporary standard of living boost when it borrows and spends the money on consumer goodies, and then endures a standard of living cut when it works extra hours and abstains from consumption so as to repay what it has borrowed.
But the pound sterling was devalued by 25% in 2008 and no one in the UK noticed far as I remember (apart from those taking foreign holidays, buying foreign cars, etc.). No disastrous levels of "repression" there.
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