Many people in the Western world believe to be free. What they don't recognize is that their governments and central banks are putting them in ever heavier chains of what can be called financial repression. While direct taxes are unpopular, things like inflation or indirect capital controls have been a treacherous tool for governments to extract monetary resources clandestinely.
In newspapers and financial circles, one reads and hears again and again about financial repression. Repression sounds like a terrible word. The synonyms for this term are quite hideous: oppression, harassment, or servitude. In the West, however, the general impression seems to be that there is little financial repression. On the contrary: mobile banking makes banking and payment always seem easier, ever-cheaper financial products make investing more affordable and trading apps make the financial markets more accessible. So where's your financial repression some might ask?
When we speak of financial repression, we need to understand that one segment of financial actors benefits systematically from today's financial plumbing: the ones that have debt on their balance sheet. Indeed, the term financial repression is understood to mean the following: The aim of financial repression is to reduce the real extent of the government's debt and to lower the state's financing costs below a number that the government would need to pay under purely competitive conditions. So financial repression includes all measures that are at the expense of the state's creditors. In the course of increasing financial repression, the financial and capital markets serve less and less the private sector, from whose wallet financial resources are shifted to that of the state.
Direct and immediate measures to cut a government's indebtedness are debt default or tax increases. The former, however, would cause deflationary shocks in our monetary system, because it would lead to a significant balance sheet contraction and cascading effect. The latter, on the other hand, is unpopular and therefore rarely a suitable option, especially in today's high-tax Western countries. The ideal solution is therefore often the devaluation of debt through monetary expansion. The classical means for this is the artificial lowering of nominal interest rates through interventions in the money market. The direct consequence of this is that the state, the largest debtor in the economy, has to pay less interest on its loans. In order to artificially lower market interest rates, the central bank buys securities, especially government bonds, in the current system. This monetization of debt instruments ultimately corresponds to monetary inflation. A so-called asset swap takes place: Central bank swaps liquidity for securities.
The increase in central bank liquidity can lead to a decrease in the value of money, which in turn reduces debts and receivables. Due to the continuous monetization of government debt by central banks, redistribution of wealth towards government is the result. The state can refinance itself continuously - thanks to falling nominal interest rates, it is even able to settle older debts with a higher interest burden by means of new debts on which it has to pay lower interest. Negative interest rates drive this redistribution to the extreme: the state now receives money directly for going on a borrowing spree. This redistribution is also promoted by the regulatory privileging that government bonds have because of regulations like Basel III for banks and Solvency II rules for insurance companies.
For debtors, financial repression is a hidden blessing. For creditors, it is all the more insidious because it is gradual and less obvious than direct tax increases. Financial repression is thus carried out indirectly and unnoticeably, which is why it is perceived and felt only unconsciously by a broad section of the population.
The following indicator shows that the low to negative interest rates have led to a redistribution of money to the state at the expense of savers: The yield purchasing power. This indicator shows that your investments generate ever less yield because of falling interest rates. The danger of having to liquidate investments for continuous income is increasing, which is rather bad from the investor's point of view. The following example illustrates this. A pensioner needs 20'000 CHF per year. If his savings contributed an average of 5 percent, he would have to have savings of CHF 400,000. At a 1 percent rate of return, he would already need CHF 2 million and at 0.1 percent he would even need CHF 20 million. This calculation example illustrates the underestimated extent to which low-interest rates affect savers. Small savers in particular are affected more often because they have fewer options to shift assets into higher-yielding investments. Savers who have to liquidate their savings are like farmers who live from their seed corn rather than from the harvest. In the long run, this is devastating, since less and less capital is available for productive purposes.
In connection with financial repression, there is also talk in certain circles of hidden expropriation of citizens by the state. However, those who consider the state to be an economically capable actor would easily consider this redistribution a good thing - after all, the public sector receives more finance for projects and investments. This view is often countered by the view that the state, by definition, is consumption-oriented and that financial redistribution to the state would therefore generate more costs than income in the medium to long term.
From an economist's perspective, cash is the main obstacle to pursue an even greater financial repression through the policy tool of negative interest rates. Without cash, it would be possible for policy-makers to break through the so-called "zero lower bound", the zero percent lower limit for nominal interest rates. This mainly psychological threshold of zero is hardly dared to be crossed by fiscal policy-maker today, as the risk of an even greater flight into cash is considered too high. In addition to the usual reasons like anonymity and terrorist financing, cash is therefore also increasingly being criticized as an obstacle to new monetary policy paths (i.e. "more innovative" financial repression). In this respect, the International Monetary Fund (IMF) in particular has stirred up attention with some published research studies that discuss the effective introduction of negative interest rates combined with possible cash restrictions.
It is difficult to assess how much longer cash will be surviving. The amount of cash in circulation has risen continuously since the turn of the millennium, both in Europe and in the USA. At the same time, Fintech, credit card companies, but also retail and service companies are working to reduce the amount of cash in circulation. And central banks have also been discussing the concept of digital central bank currencies (CBDC) for some time. Especially the latter would certainly undermine cash as printed freedom with its anonymity preserving character.
In Europe, we are seeing more and more significant cash restrictions. In Spain, cash transactions between customer and merchant are only possible up to 2,500 euros. In Belgium, the use of cash for real estate purchases is completely prohibited. Switzerland has no cash upper limit, but there are money laundering due diligence obligations for merchants above a certain cash amount of currently 100,000 Swiss francs. Within the EU, on the other hand, cash typically requires declaration when crossing the border, despite the fact that there is the policy of free movement for goods.
Cash restrictions are to be seen as informal capital controls. Today, such controls are also the result of increasing financial market regulation, which in fact can make capital and payment transactions more difficult. For example, there are branch office obligations for third-country providers. In the case of the EU, this means that third-country providers must provide part of their investment services from their EU branch and may not use domestic client advisors. Due to costs incurred, such a branch is usually not provided, which in turn restricts the investment universe for investors. Formal controls on capital movements, another form of financial repression, are currently not really in place, neither in Switzerland nor in the European Union. However, in times of increasing politicization of the financial markets and an intensifying devaluation battle between national currencies, formal capital controls are likely to suddenly become a topic of discussion again.