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Scott Schamber
November 8, 2023

Financial Repression 2.0

The shift we saw over the past couple of years has been a historic one and its implications are sure to be far-reaching and long lasting. After over a decade of monetary easing and ultra-low interest rates, a policy direction that came to a crescendo during the pandemic, inflation finally and inevitably reared its ugly head.

At first, central bankers shrugged off public fears by claiming the phenomenon was “transitory” and that prices would soon return to normal levels, as everything was under control. When that tactic proved to be ineffective, mainly because its core tenet was proven blatantly untrue, a massive policy reversal took place, and interest cuts turned into interest hikes. This measure, however, failed to rein in spiraling prices as central banks had hoped. Months went by, and then a year, and that pesky inflation problem refused to go away. Sure, official CPI figures did decline from record highs in some advanced economies, but these figures are far from accurately representative of the actual, real-life expenses of the average household.

At this point, it appears that higher prices are something people have accepted and learned to live with. Yet this pressure alone, severe as it is especially for lower-income households, might have been survivable if it weren’t for the additional pressure applied by the higher rate environment. Businesses small and large have felt the sting of the higher costs of borrowing, and individual consumers have been cornered by this “pinch maneuver” of higher prices and costlier credit. As a result, the entire economy has come under threat of a serious and prolongedrecession. And while major central banks have begun to pivot to yet another U-turn, by pausing rate hikes and preparing for a return to easy money and QE, it can be argued that by now, it is “too little, too late”.

Does the left hand know what the right hand is doing?

There is no doubt that the belief in the idea of total central bank independence is objectively naive. Some are more discreet than others; for example, China’s PBOC is clearly a lot more overtly politically “malleable” than the Fed. However, no central bank is truly, actually, and thoroughly independent, nor have they been for years - arguably since their inception. What’s different this time is that the political need in Western economies for accommodating monetary policy is getting more dire by the day, as is the pressure on central bankers to forget about inflation and focus on economic growth - or at least stability - regardless of the long-term cost.

On top of the existing raging war in Ukraine, there is another one in Gaza now which threatens tospill over to the entire region. Higher interest rates have also been very detrimental to public debt servicing costs. On top of that, there’s an election on the horizon in the US and the incumbent will need full state coffers to woo voters and secure alliances with big spending programs, as is usually the case during pre-election years. Additionally, businesses that were kept artificially alive for years thanks to cheap credit have been massively downsizing or even folding, while banks have already shown signs of cracking under pressure. All these problems and concerns are as crucial to resolve as they are expensive, and the solutions could prove unaffordable without a full return to easy money.

Financial repression is loosely defined as "policies that result in savers earning returns below the rate of inflation" to allow lenders to "provide cheap loans to companies and governments, reducing the burden of repayments." This is what we saw during the QE era, of course, and it is what we can expect to see again after the coming policy U-turn. Savers will once again be punished and penalized, while speculators, debtors and over-leveraged businesses will be rewarded. “Zombie companies” will roam free once more and the stock market will have anotherspectacular, but short-lived and totally artificial, rally due to another wave of asset price inflationfueled by cheap credit.

However, this time around, there will also be the “permanently higher plateau” of consumer prices to contend with, a problem we didn’t have last time. Pursuing an extremely inflationary policy in an already inflation-stricken economy doesn’t sound like a strategy that will yield any positive results for anyone apart from the state and state-connected or -dependent enterprises.

No way out

It isn’t just inflation that is adding a new complicating factor into the mix this time, though. Thereis another key part of the equation that has changed since our last experiment with monetary easing and ultra-low interest rates. During the previous era of ZIRP and NIRP, savers and investors had a few options if they wanted to avoid seeing their savings dwindle on a no-interest or even negative-interest bank account. They could “invest” their money in overvalued stocks, they could spend it, or they could simply withdraw it and wait out the storm while sitting on a pile of physical cash. Granted, that pile earned no interest either, but at least it was safe from negative rates and from the risk of a banking crisis, of which we saw quite a few, e.g., capital controls in Greece, “haircuts” in Cyprus, etc.

This last option is unlikely to be on the table this time around. Given the fervor with which central banks all over the globe are pursuing Central Bank Digital Currency solutions (CBDCs) and given the rate of progress they are making, it is safe to assume that cash could soon be facing an extinction event. The FedNow system that we already discussed in previous BFI Bullion(and BFI Capital Group) analyses is now live and it is widely seen as a precursor to the transition to a full digital dollar system. Over in Europe, the ECB recently announced that it will begin a two-year "preparation phase" in November for the digital euro, finalizing rules and selecting private sector partners. In fact, as DW reported in mid-October, “more than 100 central banks worldwide are either exploring or preparing to put in place digital currencies as electronic payments grow.”

We have already outlined the very real, practical risks of CBDCs in a previous edition of our Digger, including concerns over privacy and the potential for governmental abuse. However, what is particularly pertinent in this context is the danger of direct policy transmission. Without cash, there will be nowhere to run from negative rates, or whatever “monetary experiment” comes next. After all, if the absurd notion of paying for the privilege of lending your money was so easily normalized and constituted official policy in the Eurozone, in Japan and elsewhere for years, what’s to stop central bankers from going a step further to combat the next crisis, especially if they have a “captive audience”?

With CBDCs the possibilities are endless: from directly enforcing negative rates on individual savers, to employing the concept of “programmable money,” to enforce bans on purchases or investments that are not “sanctioned”, or to create stimulus payments with an expiration or “spend by” date.

The true cost of fiscal activism

Even beyond all these known risks from the monetary side, there are very serious concerns that investors urgently need to consider from the fiscal side too. As the FT highlighted in a recent analysis, “Governments have been emboldened by their interventions during the pandemic and the recent energy crisis in Europe, when they organized the rollout of mass vaccination programs and financial support packages to households and businesses. The revival of big government that is more active in addressing social needs brings the need for higher public expenditure to solve problems... Unprecedented government support to businesses and individuals during the pandemic has already pushed up public debt levels in many advanced economies, while a spike in inflation has triggered a surge in interest rates as central banks battle to tame rising prices. Increased debt levels and higher interest rates will make it harder and more expensive to borrow in the financial markets, especially for day-to-day spending.”

The next best thing to borrowing is of course taxing. It’s certainly not an easy sell, especially in advanced economies where the taxpayers are already carrying a heavy load. It can, nevertheless, become more politically “marketable” under specific circumstances. As the FT alsohighlights, “levels of taxation remained fairly flat until this decade, but they have been rising since the pandemic. The average was 34.1 per cent in 2021, according to the OECD.”

If a pandemic can be a persuasive reason to get voters to agree to parting with a higher portion of their hard-earned money, then a war is bound to be an even more compelling argument. This is particularly true for a generation that hasn’t even seen one on TV, barely remembers the invasion of Iraq, and is now facing two active war fronts that could spread and morph into a much wider conflict, potentially involving direct Western participation.

But we don’t even need to tax our imagination to conjure up such dramatic or extreme scenarios.There’s always another “door” to tax hikes and it has already been tried and tested. Climate change has led to the emergence of an entirely new sector within the financial services industry, to wit ESG and green investing, as well as a wave of regulatory interventions and new taxes. Most of the direct tax hikes or new taxes have so far been aimed at the corporate world, but indirect burdens have also targeted individuals too. The (in)famous Ultra Low Emission Zone (ULEZ) in London, for example, introduced daily emissions-based charges for all non-compliant vehicles driving in that zone, forcing many citizens to pay £12.50 a day to use their car to get to work. One can easily envision this sort of policy being applied more widely, while still evading theofficial definition of a “tax,” as it still presents a choice, albeit an impractical one.

All in all, just as we described in detail in our latest Special Report, Deeper Into the New Era - Navigating the Shifts & Turning Points Ahead, it should be clear to all investors by now that we have entered a whole new chapter in terms of monetary and fiscal policy. Financial repression, emboldened governments and a destabilized world order all present new and serious challenges for long term financial planning.

With equity investments, pension savings, bank accounts, and now even cash failing to provide a safe haven from what lies ahead, physical precious metals remain the only reasonable and reliable choice for those who seek to protect what is rightfully theirs.

This article was published by BFI Bullion Inc. in their recent newsletter "Digger Quarterly".

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