“ Go for the Bomb “

You may have noticed a relatively new term being used in the financial media recently “Financial Repression” is the latest buzz word being bandied about.  But it really isn’t a new idea and just means robbing savers to pay government debts.

Traditionally there were two routes open to government to pay down enormous deficits, one was to hyperinflate or repudiate on debts.  To hyperinflate the government would simply print enormous sums of cash (Weimar Germany) thereby destroying the native currency in process paying off debt with worthless cash.  The method is highlighted by the tale of German farmers who is the 30’s would sell a wagon load of potatoes, fill the wagon with cash, then drive it to the bank to pay off the previous large note of the farm.

The government in much the same way uses inflated money to pay back previous dear debts.

The second traditional path was to just default on the debt.   The debt was eliminated by refusal to pay.   Many times this refusal to pay drove the market price of the debt down. (Think African nations default on World Bank Bonds) to a couple of cents on the dollar.   The defaulting nation thus buys back the debt for a song and expunges the debt.

The 3^rd method is the currently referred “Financial Repression”, which uses a combination of inflation and low interest rates within a jacket of capital controls to take savers money gradually over time to pay government debts.

The first aspect of this program is Federal Reserve control of low interest rates upon savers and investors.  The Federal Reserve manipulation of interest rates insures  the loss of value 3 of 4% per annum, gradually debasing the currency and aiding in the repayment of debt.

The second force that is unleashed is that of inflation.  Remember Bernanke’s recent speech where one of the key things the Fed was attempting to do is create inflationary pressures to prevent Deflation and Depression.  Inflation is the government’s friend, it pushes people into higher and higher marginal Tax brackets thereby increasing government revenue.  At the same time inflation reduces the debts the government owes.  Recent Q.E. moves indicate this inflationary bias.

The third part of the government‘s agenda is capital controls whereby an investor’s ability to get their money out of the country into hard currency is curtailed.

Capital controls may take the form of confiscation of certain financial assets such as gold which the government did earlier in it’s history.   The prevention of the populace from converting it’s dollars into gold would lock you into an investment tied to a declining dollar and make you a sheep ready for shearing.

Another form this control of assets could take could be mandatory exchange of retirement account assets such as 401K’s or IRA’s into government zero coupon bonds or treasury bond backed annuity schemes.

One face of this repression could be “Mandatory Safety” rules put on banks, insurance Co’s, credit unions to invest their funds in government debt this could be masked with the illusion of protecting depositors-policy holders from “low quality” investment in the private market place with different tiers of assets and corresponding safety levels, much as what is “supposedly” mandated by the Basel Accords on banks.  By regulation the government could nudge financial institutions to load up on government debt.

One insidious aspect of this repression is that while savers would be forced to accept below inflation returns-Financial institutions would still be able to make healthy profits because banks make their profits on the spread of what they take in and pay out.  Because banks are able to obtain funds at zero cost, they are able to lend out at very low rates and still make a healthy return.  Banks and hedge funds also use substantial leverage to magnify gains several times.  The fact that our banking system is a fractionalized reserve banking system also multiples profits for banks.

In looking at the current funding situation the treasury is in it can be argued that it is almost a requirement that the Fed keep interest rates low forever.  Nominal debt due to current deficits is increasing at a rate now of a trillion and half plus per year.  While most of this debt is very low interest rate debt, it is of short duration that is short term in nature.  The overwhelming majority of the Treasury’s Debt structure is short term which means interest rate increase on the short end would have dramatic effects on total interest outlays.  It has been calculated that at a point when the average for interest on T-Debts reaches 5 to 5&1/2% (Historically Normal Interest Levels), the entire tax collection on the U.S. economy would not be enough to pay total interest on the debt.  It must be remembered that current budgetary deficits would be adding 1.5 trillions plus of new debt each year into a situation where the U.S. could not pay interest on all the debt that was previously created.

So in reviewing the options available to the government – Default , Hyperinflation or Financial Repression the later option seems the most likely solution.  It is probably a question of whether repression is utilized as a pre-emptive measure or as a desperate Hail Mary Act.  The hour is late, the game is down to the last few seconds, the two minute warning is here the total debt clock is winding down. Tick, Tick Tick!!!!!!