For super funds and their advisers

‘Financial repression’ rises from the ashes

•7-Didier-Borowski

Tomorrow is starting to look a lot like yesterday, with policymakers leveraging lessons from post-war Europe to solve the new problems barrelling towards us. Free market thinkers will likely chafe.

“Financial repression” is the institutional constraints on interest rates designed to reduce the government’s cost of funding and shrink public debt. The term, coined in the 1970s as the opposite of then-emerging economic liberalisation, is best represented by a triangle of instruments – monetary policy, financial regulation, and government action.

“The intensity and effectiveness of each angle are different, and so is its strength. Monetary policy can be considered as soft and regulation as soft to hard, while government ruling is, by definition, hard,” wrote Didier Borowski, Amundi head of global views, and Pierre Blanchet, head of investment intelligence, in the company’s latest Thematic Global Views report.

“Moreover, financial repression is not an iterative mechanism. Each angle can be “on” or “off”, with different intensity and strength at different periods. Today in advanced economies, monetary policies and regulations are “on”, while government ruling is mostly “off”.”

Financial repression tends to emerge in times of crisis – for example, post-WWII Europe and the United States, where it was used to manage and reduce public debt relative to GDP. The conventional wisdom, in the aftermath of the extraordinary policy measures unleashed during the Covid-19 pandemic, was that the genie was out of the bottle and that these settings could become the norm – ushering in a new era of financial repression.

Recent moves to taper policy, and an acknowledgement from central banks that the party must end, now has some investors convinced that’s no longer the case. But the authors believe that the genie was actually allowed out of the bottle 15 years ago, during the Global Financial Crisis, and that it will now work its magic (to extend the metaphor) with greater intensity.

That’s due mostly to the cost of the transition to net zero, which will require industrial production to be repatriated from emerging markets along with the construction of renewable assets – projects that require “a lot of capital and long lead investments”.

“We believe “repression” will not recede but actually intensify, with the regulatory angle strengthening and probably government ruling switching on, as the need to channel capital to achieve decarbonisation will be critical,” Borowski and Blanchet wrote.

“This “repression” is likely to be seen as a positive and not a negative to achieve the higher purpose of net zero versus return on savings. We should therefore assume that interest rates will remain low relative to nominal growth for a long time.”

As the authors note, the main argument against it – aside from emotive responses to the name – is that it discourages saving over investment and limits the ability of financial intermediaries to efficiently channel capital. In the long term, it would reduce growth potential. Financial repression is more effective when combined with inflation – tick – which comes as a consequence of excessive money creation, expansionary fiscal policy, or a host of other measures.

“Any of these, combined with the twin angles of monetary policy and regulation, should be enough to ensure an efficient transition to decarbonisation,” Borowski and Blanchet wrote. “However, the harder version of financial repression involving governments can’t be excluded. It would require some market turbulence, though, and maybe another crisis to be justified and implemented.”

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