Sunday, December 11, 2011
Financial repression for bond buyers
The most important credit- fixed income meme is the idea of financial repression as a solution for the sovereign debt crisis. It is can come in many forms but the easiest is for governments to keep real rates below zero. Debtors are a beneficiary if the rate of interest is anything below the growth rate in the economy. So we get the central bank to lower rates below the inflation rate. We get negative real rates.
Additionally, we get coordination between the fiscal authority and the central bank. The central bank can buy debt directly and print money. The coordination of the US Treasury after World War II pegged rates to the wartime levels. The Treasury-Fed accord of the 50's ended their coordination but then rising inflation cut the real value of the bonds. The bondholders were the losers and the government was able to being down the debt to GDP levels which reached highs above 120 percent of GDP.
Finally, we regulate banks to keep rates low and make sure that alternative investments are expensive relative to Treasuries. These policies work. They are part of our financial history. It would be very simple to bring them back. Wait we may have already.