Notes on financial repression

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Financial repression is a term used to describe several measures that governments employ to channel funds to themselves, that, in a deregulated market, would go elsewhere. Financial repression can be particularly effective at liquidating debt.
Financial repression includes:1. directed lending to government by captive domestic audiences (such as pension funds)
2. explicit or implicit caps on interest rates
3. regulation of cross-border capital movements
4. (generally) a tighter connection between government and banks.


Five ways to reduce debt-to-GDP ratio:
1. Economic Growth
2. Austerity
3. Default, or restructuring of private/public debt
4. A sudden surprise burst in inflation
5. A steady dosage of financial repression that is accompanied by an equally steady dosage of inflation

Implication:
1. To deal with the current debt overhang, similar policies may re-emerge in the guise of prudential regulation rather than under the politically incorrect label of financial repression.2. This decoupling between interest rates and risk is a common feature of financially repressed systems. With public and private external debts at record highs, many advanced economies are increasingly looking inward for public debt placements.

Critiques -

• Ignazio Visco , governor of Bank of Italy
  

- financial repression may distort choices and allocations and undermine the incentive for fiscal discipline, as was the case in Italy in the 1970s and 1980s. Secondly, I doubt that it would actually be feasible – the financial markets are much more highly integrated today than they were from the end of World War II to the 1980s and capital movements much less strictly regulated – unless financial and real protectionism were to prevail, which would be a serious blow to international cooperation and to well-being. It also needs to be recognized that owing to conventional and unconventional monetary policy, nominal interest rates are already quite low today.

- My conclusion is that the reduction of government debt can only be pursued by a demanding combination of fiscal consolidation, stimulus for economic growth (through structural measures to enhance competition and innovation and foster the accumulation of human and physical capital), and – the real last resort – debt restructuring.

• Taylor, Morgan Stanley
  

- History shows that when uncertainty shocks hit, real rates always drop, and this is indicative of investor fear, and is not a reliable symptom of financial repression.

• Related links:
  

http://en.wikipedia.org/wiki/Financial_repression
http://ftalphaville.ft.com/blog/2011/12/12/793411/financial-repression-part-i-a-recap/
http://ftalphaville.ft.com/blog/2011/12/12/794121/financial-repression-part-ii-a-critique/
http://ftalphaville.ft.com/blog/2011/05/13/568586/help-were-all-being-financially-repressed/
http://www.bis.org/publ/work363.pdf

My takeaway: Financial repression has always been a hot topic, especially in China. As far as I see, China has all four symptoms of financial repression. Chinese household income is severely repressed by low interest rates and high net interest spread in the banking system, which is basically the entire financial system in China. The SOEs get cheap financing and invest in wasteful projects. The household also lack investing oppotunities because of capital regulation (foreign market), poor corporate governance (stock market), fixed interest rate (bond market) and so forth. Someone even estimate that Chinese household lose more than one trillion RMB each year due to financial repression. If China really wants to rebalance, the household income must be lifted and financial repression resolved, which, based on present situations, will not happen any time soon.

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