Make no mistake you are being financially repressed.
You may not have heard this term mentioned in relation to your personal finances so firstly, I will explain what financial repression is before outlining some of the methods currently being used to financially repress you in the UK.
It’s important to understand the concept of financial repression so that you know the effect it has on your wealth.
Generally, financial repression is achieved by using some or all of the following methods:
b) Government ownership or control of domestic banks and financial institutions with barriers that limit other institutions from entering the market.
c) High reserve requirements.
d) Creation or maintenance of a captive domestic market for government debt, achieved by requiring banks to hold government debt via capital requirements, or by prohibiting or dis-incentivising alternatives.
e) Government restrictions on the transfer of assets abroad through the imposition of capital controls.
Indebted governments of the world want their citizens to become like Ross Geller in Friends, and get excited over low yielding bonds!
In the UK, we have the following debt levels across our economy:
The major problem is we cannot come out and explicitly say that we cannot pay our debts. That would undermine the entire house of cards that represents our financial system (think Greece).
The alternative approach being used is a gradual, manipulative, dishonourable and downright sneaky attempt to inflate away our debt obligations, so that we can repay people with numbers that have reduced purchasing power.
As an individual saver, this is a problem for you because banks, governments and indebted households intend to escape from their excessive debts at the expense of your savings, wealth and prosperity.
Explicit or indirect capping of interest rates, such as on government debt and deposit rates.
More recently, it is activist monetary policy by central banks that essentially put a cap on interest rates. By lowering the BoE base rate, it lowers the rate offered by banks for savings deposits and drives down the yield of other riskier assets.
By way of example, if the amount available on cash deposit is only 1%, you will be more willing to accept a low 2% yield from government bonds, 3% from corporate bonds, and 4% from equities.
If the BoE base rate were 5% however, all of the above riskier yields would look rather expensive, and logically you would want a higher yield in payment for the increased risks involved when lending to the government or businesses, or attempting to share in the profits of companies.
The Bank of England interest rate was moved to historic absurd lows of 0.5% in March 2009 and there it remained for seven years, before dropping even further to a farcical low of 0.25% in August 2016.
To provide some perspective, here is a chart showing the history of the base rate going back a few hundred years. It shows how our current monetary policy is so bizarre, unchartered, and in my view, highly dangerous.
So today, due to activist and purposefully manipulative monetary policy, we now have the following yields on all assets:
Dr. Jerome Booth, an emerging market investor summed up the government aims of monetary policy in a recent article:
The Bank of England, by reducing the cost of credit and fraudulently participating in financial markets, have placed us in a truly bizarre financial landscape, and these techniques alone have achieved a certain level of financial repression. However, there are other factors that can make financial repression more effective and prevent your ability to escape from its wealth reducing impact.
Government ownership, or control of domestic banks and financial institutions, with barriers that limit other institutions from entering the market.
In a free and competitive market, that is what would happen. The newcomers would raise service standards and operate in a different way to the incumbent banks and attempt to displace them from their privileged positions. Despite all the media rhetoric about free markets (usually with the accompanying misplaced blame for the financial crisis), we don’t operate in a free and competitive marketplace. We never have. Not in the slightest. It is a big crony corporate and government love affair that the public have to endure and whose rule and influence we have to live under. Our economic and political system is an unhealthy combination of fascism and socialism; neither of which are particularly attractive or clever ways to operate our economy and do not form a lasting bedrock for a stable society or prosperity.
Apparently, only one bank in the last 150 years, Metro Bank, has received a banking licence from scratch (most ‘new banks’ are offshoots and buyouts of existing banks and licences). This is despite only four lenders having a 75% market share, and their incompetence and greed causing all sorts of issues, seemingly on a weekly basis.
The PRA, would no doubt say the lengthy, onerous and restrictive process for obtaining a banking licence is to protect consumers, but that kind of policy position is surely exposed as hypocrisy by the activities of the existing banks that do already have licences.
While some new banking start-ups look encouraging, in a truly free market, these newcomers would already be making large inroads into market share, not just making start-up hype headlines. In my view, the more newcomers we have, the better off we will all be. We really need to shake up this sector and force the incumbent banks to either shape up, or get shipped out.
Unfortunately, I feel most of the more recent banking start-ups are doomed to operate at the margins; the banking sector operates as a closed elitist club, backed up by the Bank of England, political power and taxpayer pockets.
Well they can’t just have any old so and so committing financial fraud can they!
This protection of competition helps ensure that those in the club can control credit creation in a way that suits their own purposes, but it also means they can be manoeuvred to do the bidding of the government.
It’s simply the price paid for being a member of the credit creation club, with assured protection from the government and the Bank of England.
High reserve requirements
The banking system operates on a fractional reserve basis. When this system is actually explained to anyone outside of the financial sector, nearly everyone would say something akin to, Well that’s blatant fraud, how on earth can that be legal?
Unfortunately, private bank credit creation (which is then used by everyone as if it is money) is perfectly legal in our corrupt world.
They don’t take in a pound for every pound they lend out, it’s a little more complicated (every good fraud is!). Essentially they only have a set amount of reserves on their balance sheet to offset the risk of their loans and to meet their obligations to their own creditors (i.e. those entrusting their money to the bank on deposit).
There are regulations (again extremely complex), which dictate how much a bank needs to keep in reserve for each type of lending activity they are involved with.
You can get a good overview of the importance and confusion of banking capital reserves at Finance-watch.org however, as a general guide, banks were operating with reserve ratios as low as 1.5% in some cases, and now they need to be a minimum of between 8%-10.5%.
This is a very important and positive move in the direction of bank stability, however the result from a financial repression point of view, is due to these regulations being fiddled by the banking sector (which means all kinds of manipulations of the numbers).
One of these manipulations of bank capital requirements is the ability of banks to risk weight their own assets, before applying the capital reserve requirement.
The unintended consequence of this capital reserve leeway (or intentional consequence if you prefer your hat to be of the tinfoil variety) is that government bonds are still commonly risk weighted between zero to minimal risk!
Again, finance-watch.org outlines a neat explanation of this insane manipulation and ‘fraudulent’ sidestepping of regulations.
In Part 1 (“How is bank capital regulated?”), we saw how risk-weighting can allow a bank to meet an official 8% total capital requirement and still operate with less than 3% of its unweighted assets being funded with capital
It is a simple but controversial concept. Here is how it works:
The value of each individual asset is weighted, or adjusted, by the bank for regulatory purposes according to how risky the bank believes the asset to be. The bank then applies the capital requirement to the risk-adjusted numbers instead of to the actual value of its assets. For example:
A “safe” mortgage loan €100,000 might be risk-weighted at 15% and so adjusted down to €15,000. Applying the 8% capital requirement would give a capital charge for this loan of €1,200 (100k x 15% x 8%).
A “riskier” loan of €100,000 to a company with a moderate credit rating might be risk-weighted at 50% and adjusted down to €50,000, giving a capital charge of €4,000 (100k x 50% x 8%).
The minimum capital needed to fund these two loans would be €5,200 (1,200 + 4,000). This is only 2.6% of the €200,000 in loans that the bank has made, but the magic of risk-weighting means the bank still complies with the 8% total capital requirement.
Why does this contribute to financial repression?
Well as government bonds are deemed ‘safe’ Banks have been loading up on government bonds.
According to a report for the European Parliament, sovereign debt in the Eurozone is still risk weighted at 0% (yes, zero) and EU banks have nearly doubled their holdings since the crisis!
The increased demand for government bonds creates a captive audience, pushing up demand for government bonds and therefore lowering the yield.
This again reduces the ability of you as a personal investor to obtain a reasonable return on your money from safer assets, causing you to go chasing returns in bonds of lower quality (now called high yield, previously and surely soon to be re-termed, junk bonds), as well as all sorts of other risky speculations masquerading as investments.
Creation or maintenance of a captive domestic market for government debt, achieved by requiring banks to hold government debt via capital requirements, or by prohibiting or dis-incentivising alternatives.
In general terms, government bonds are low risk for the following reasons:
- They pay a set coupon every six months. This provides a good level of certainty over the income you will receive during the term of the bond.
- The income is not dependent on business performance.
- The likelihood of default is low as government revenue is protected by the use of force against the taxpaying public.
- Due to the above merits, there is a large pool of investors willing to lend money to the government, which therefore provides high liquidity and low volatility.
These are all strong factors towards government bonds being seen as low risk and generally, lower risk than other assets such as shares. However, the result of this view is that many pension funds, insurance companies and financial advisers appear to have accepted this position as fixed and certain. I fear that some blindly follow financial theory, whilst others are reluctant bondholders, but given the present situation, the government doesn’t deserve to have this large captive audience for it’s debts.
The big issue with the view that ‘government bonds are low risk’ is that whilst it is generally true, it isn’t always so.
We constantly fail to incorporate how our views and actions, the prevailing price and government decision making, all impact upon the market risk of all financial assets, not only government bonds.
For example, thirty years ago 10-year Gilts were yielding over 10%, yet today, they are yielding just 0.796%.
As the likely future return from these bonds has declined, it is only logical to assume that the risk of holding government bonds has significantly increased.
With a yield of 10%, there is a large safety margin in case of anything not going according to plan (inflation, default, investor panic etc.), however with a yield of just 0.796%, everything basically has to go in your favour, essentially just to get back your original capital in 10 years time. It’s an investing tightrope with no reward on offer, merely survival if you are lucky enough make it to the other side unscathed.
The real possibility is some form of severe financial panic or loss in these markets. By investing in government bonds today you are taking risk without any compensation; you are picking up pennies on a train track.
It would take just a small increase in yield to dramatically affect the price. For example the 5% treasury stock 2025 currently yields just 0.665%.
If the running yield moved back to the coupon of 5%, the price would need to decline by over 25%. If you have shorter duration bonds you can simply ignore these fluctuations and wait until the bond matures, but with longer duration bonds, any increases in yield are going to cause you financial problems.
Let’s also look at government decision making, or level of debt. Surely, lending money to the UK government in 1990 when the debt to GDP was 25% is lower risk than lending to them today, when the debt to GDP is 90% (and I won’t even go into undeclared government debts via pension obligations).
Finally, subjective views are key.
In my view, people continuing to believe government bonds are low risk, is a big factor towards actually keeping them low risk. It’s a self-reinforcing concept. There are few fundamentals backing up the low yields of highly indebted governments. The price is now entirely based on the subjective opinions of professional investors, and helped by the heavy demand from central bank manipulation.
Unfortunately, as so many investors have been force-fed inflexible financial theories and opinions, the result is that people appear to be behaving as if government bonds are always low risk no matter the price, or how the government behaves.
When these views change, the drawdown of bonds will cause the same fright as the first few seconds of jumping out of a plane; travelling south just as quickly while your heart is in your mouth. Unfortunately there is no parachute, it won’t have a happy landing, or provide any adrenaline-induced euphoria; but rather bankruptcies, panic and fracturing of a patched together financial system.
One look at the recent experiences of Greece, Ireland, Italy, Spain, Portugal (I could go on) and you will know that whilst bonds are generally not as volatile as equities, the price can draw down extremely quickly and by very large amounts (essentially the bid disappears). Therefore, in the wrong circumstances, bonds can be just as high risk as any other investment, perhaps even more so.
In my view, Government bonds are no longer low risk; they are now only low return, with impending loss.
Government restrictions on the transfer of assets abroad through the imposition of capital controls.
The UK hasn’t directly taken this approach, however we have implemented a number of measures that impact on the ability of the average person to manage their finances globally.
Under the guise of preventing terrorism and tax evasion, there is significant bureaucratic, regulatory and public demonising of managing your finances outside of the UK into so-called ‘offshore tax havens’. The hypocrisy of this position is laid bare when you actually look into the tax situation our own country has in relation to the world; we are ourselves a small island with comparatively favourable taxes to many other countries. The only thing we are missing to achieve true ‘offshore tax haven’ status is the exotic weather.
To further the aims of indebted governments to control their citizen’s money, there also appears to be a gradual discrediting of cash.
Fund manager Tim Price feels this war on cash goes further than usual financial repression, and is an impending form of martial law. This consists of negative interest rate policy, restrictions on bank access in times of crisis (bank bail ins – such as experienced in Cyprus), and finally the war on cash:
Here are some methods the government uses to restrict the transfer of assets abroad:
- Try taking more than €10,000 out of the UK in cash and you will probably raise more than a few eyebrows.
- The failure to publicly explain the difference between tax avoidance and tax evasion, with the result being that any form of tax avoidance, especially by large corporations or wealthy people, is pilloried by the media. How many people are effectively scared off from legitimately managing their finances globally by this kind of public demonising? A relevant example would be Jimmy Carr’s tax affairs. I do not know the particulars of the case (admittedly, it sounded a little dodgy), but it speaks volumes about our government when our Prime Minister can publicly condemn a person before any form of guilt was legally established; yet pedophiles, to take the worst type of criminal, can remain anonymous in your neighbourhood.
- The media also misunderstand the valid and proper use of structures of ownership (i.e. company structures and trusts). Admittedly, some villains will make use of these structures and some will inappropriately use some of their features for immoral personal advantage, but when the media publicly demonise an entire sector it should raise an alarm about erosions of personal freedom and privacy. You cannot blame legitimate and reasonable management of your personal affairs for the actions of a few. Sure, villains, like the rest of us, also use things like oxygen and water, yet we wouldn’t feel the need to restrict their usage would we?
There are also a number of other methods available, that thankfully, the UK is not yet guilty of. These could be the USA FATCA rules, or enforcing a notional capital gain on assets when you give up residency of a country (such as that imposed by Canada). Rather than enforce explicit legislation and restrictions, we appear very adept at publicly making other countries appear riskier and less honourable than our own, awarding ourselves some form of self-imposed moral financial high ground, which the facts do not necessarily support.
The UK is not a place that is immune to the results of poor financial management. We would be wise to retain a healthy dose of scepticism about our government and financial sector, and whilst there are positive factors in favour of wealth preservation in Britain (one being long standing private property rights), we may not necessarily live up to a ‘safe and sound’ place to store, maintain and enhance your wealth.
We do have past form of government mis-management of our finances.
In 1976, we went cap in hand to the IMF for a financial bailout, keeping such esteemed company as Argentina, Greece et al. Additionally, due to effective propaganda (professional, government directed, widespread lying) we were even able to avoid the unwanted label of ‘bond defaulter’ in 1932 by persuading a reduction in the coupon of the war loan from 5% to 3.5%. Whether it is official or not, ‘voluntarily’ reducing your yield provides the same loss of return as an enforced one.
It is clear to me that it would be unwise to leave your finances at the sole mercy of the British government, however when you add up all of the factors of financial repression, it makes it challenging to preserve and enhance your prosperity over an extended period of time.
These restrictions and limitations on your financial freedom are frustrating and bizarre in our modern and global world.
Let me ask a legitimate question. If we can shop globally for the best car or choice of food, why can’t we choose to deposit our funds with any bank or investment in the world, at any time and without any restrictions or inconveniences?
The only conclusion to draw is that the powers that be wish to funnel your money into the ‘proper hands’ and they achieve this using patriotic propaganda, regulations, legislations and bureaucratic controls.
Paul Mason, in an article for the BBC, explains how the debt to GDP of developed nations dramatically declined from 100% to 20% of GDP
However, there are many significant differences between the period 1945 to 1970, and the forthcoming 25-year period.
I do not retain the same confidence that we can use financial repression to escape from our current excessive debts. There are many reasons for this:
Government’s got out of the way
World War Two resulted in the government having a heavy hand in the economy. In 1945, government spending accounted for 70% of GDP. The end of the war allowed the government to significantly reduce its role in the economy, freeing up opportunities for the private sector, and by 1970, government spending as a percentage of GDP was a lower, at 41%. If, like me, you believe the government is inherently wasteful with its funds, then this trend allowed for significant improvement in our nations finances. Today, government spending as a percentage of GDP is approximately 45%. There is less likelihood of a further dramatic privatisation of our economy, and I wouldn’t be surprised to see government spending have greater influence over our economy in the next decade or so.
We are still taking on debt
Financial repression worked between the years 1945 to 1970 partly because we were repaying historical debts (mainly the debt levels incurred fighting both World War One and Two). In 1947 we had a budget deficit of 3%, but for most of the next several decades we operated with sizeable budget surpluses. This significantly improved our government’s finances and made a huge contribution towards fixing our debt issues.
Today however, we are still taking on debts and the idea of running a balanced budget, let alone a budget with a surplus, is highly unlikely to happen. Recall all the continual nonsense and protests about austerity when the current government is still running budget deficits (I was under the impression that austerity would at least mean spending within your means. It appears to me that was mostly rhetoric for the bond markets). I’m not aware of any noteworthy movements towards financial conservatism, and I don’t expect this to change any time soon. We can hardly fix a problem of too much debt if we continue to take on more.
Debts in all parts of the economy
Our total indebtedness is far greater than the official figures would have you believe. Not only do we have huge official government debts and budget deficits (approximately £1,627 Billion and £69 Billion pa respectively). But we also have huge personal and corporate debts, with the added worrisome liability for pension payments to a large number of retirees (i.e. a debt), a liability that the government doesn’t even account for.
The chances of simultaneously keeping a lid on our levels of indebtedness and growing our economy appear quite a challenging task.
The demographics of our nation have also declined. After the end of World War Two people rushed out to have children however, following this ‘baby boomer’ generation, we have seen a reduced number of childbirths (for various possible reasons; decline of religion, improvements in contraceptives, women entering the workforce on a large scale, increased costs of raising a child etc.). The result is that whilst the period 1945 to 1970 saw increasing numbers of people entering the workforce, buying homes, starting businesses, saving and investing etc., the period 2016 to 2040 will see a large number of people leave the workforce, sell their homes and require costly medical care and support. This drain on more productive economic activity and on both personal and government finances, will have a huge impact.
Financial repression leaves little room for error
Financial repression appears akin to walking a tightrope over the Grand Canyon. There is scant room for error, and so many things can go wrong. Rather than a prolonged period of financial repression, we could instead see shorter periods of one or more of the following; debt default, high/hyper inflation, deflation, loss of confidence in financial markets and/or institutions, and war to name a few awful scenarios that have happened all too frequently in the past, and therefore its logical to assume could potentially happen in the future.
Whilst the government and heavily indebted individuals and corporations would favour a gradual erosion of their debts, I fear that financial repression will be effective at limiting financial returns, but ineffective at actually improving our debt to income ratios.
The risk, and in my view, the likelihood, is that there will be instances of more acute devaluations and/or defaults to come, before we can truly say our debt disaster has been resolved.
Even if it works, from your own personal perspective as a saver and investor trying to support your old age or your family, financial repression is going to present a huge challenge to your level of prosperity.
The one shining light that could save us from all of these potential problems is significant advances in energy efficiency and other scientific advances. Some of the things I have heard sound very exciting (if a little like Star Trek), and if we can pull off these economic improvements and escape from the present global debt mess unscathed, it would make Harry Houdini look like a rank amateur.
As of writing this article (October 2016), we have to concede that it is not just interest rates and government bonds that have been repressed downwards.
As the rate of return on these safer assets have become unattractive, people have moved to other assets in the chase for a reasonable return. This in turn increases the price, and thus reduces the yield, on the higher risk assets. In my view, the Bank of England has affected every asset, and most are generally priced above their fundamental value given the economic climate and the risk that each type of investment contains.
The decision that many people have been taking, and are likely to continue to take, is to invest into assets they wouldn’t normally invest in if the bank savings rate were more attractive.
We have turned retirees into speculators in their hungry quest for some form of return to support themselves. What people are forgetting is the inherent value of receiving a regular and real return via income. Receiving an income from investments is a very different thing to price appreciation of assets. Often, price appreciation is entirely illusory, but income is very real and tangible.
When deciding where you should invest and in what quantities, it is essential to first understand your timescales, preferences, personal views and lifestyle needs. Only then can a portfolio that is fit for your own needs and requirements be constructed.
However, as a general guide, two things are important if you wish to escape from financial repression:
- Put any thoughts of patriotism into the bin. You need to think with logic and reason, with a view only towards your own person and family. You need to have a global perspective and allocate your capital towards places that will respect it, preserve it and grow it.
- Eliminate single points of failure. My investment mantra will always be skewed towards a patient accumulation of wealth over many years. The best way to ensure that you don’t lose your shirt is to diversify, diversify, and diversify! This means across banks and financial institutions, across asset classes, across geographic locations and across political regions.
I personally feel that you have already been financially repressed and therefore escape from its effects will be challenging however, to help navigate these uncertain and perilous times, I would suggest that you consider investing into a widely diversified, ownership based, global portfolio.
The makeup of your own personal portfolio will vary with your situation, but unless you are a very brave financial genius, you should ensure that you allocate to a broad range of ownership assets to reduce the likelihood of losing your shirt.
One big call, which goes against all financial theory and most existing portfolios, is to severely limit (or avoid entirely) government and corporate bonds. These are priced for no adequate (if any) return, and hiding just below the surface is the risk of huge losses. Bonds do have some diversifying qualities when holding a large amount of shares; and therefore if you wish to own some bonds, the limited exposure should be in extremely short duration offerings. This way, you can ignore price fluctuation and the bond redemption should return your capital.
But my personal opinion is that bondholders are going to be left rather unsatisfied and unsettled by their holdings over the coming years.
Be honest with your calculations; financial repression has already happened.
Finally, rather than chasing returns in unattractive and unwise places, you need to accept that you have already been financially repressed and therefore asset prices are already inflated, causing future returns to be muted at best. It would be wise to correspondingly lower your expectations and adjust your plans.
For example, just because you require a 7% return to reach your retirement goals and have that figure outlined on a pretty chart; it doesn’t mean you will actually receive it.
If you have say, 30% of your portfolio in bonds, with current yields, logically your returns are going to be anywhere between 0.5% and say 2%, depending on the duration and issuer quality etc. (that future return may well be worse – there’s a lot of inherent risk in bond markets at the present time).
After you take off the effect of fees, it leaves other asset classes like equities, with a lot of weight to carry to provide you with anything like a reasonable return for the risks you are accepting as an investor.
A good financial plan starts with your dreams, but your plan needs to be rooted in reality.
Unfortunately, financial repression may well turn your dreams into a recurring nightmare.