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 Many people view the Federal Reserve's role in monetary policy as an unqualified good. If there isn't enough money in the economy, or if there is too much debt or deflation, then the Fed should print money until both situations are fixed.

  But it isn't that simple.
Monetary policy is a zero-sum game. It's much like Isaac Newton's 3rd law of motion: for every action there is an equal and opposite reaction.

   Not only do many people fail to understand that, they are also under false impressions of what the reactions are and who they effect.

 Let's start with the definition of Financial Repression:

 A term that describes measures by which governments channel funds to themselves as a form of debt reduction.
  Financial repression can include such measures as directed lending to the government, caps on interest rates, regulation of capital movement between countries and a tighter association between government and banks.
 That doesn't sound so bad. But consider places it has been used, such as India, Mexico, Pakistan, Sri Lanka, and Zimbabwe. Not exactly a list of economic success stories.
   The key is understanding Financial Repression is to understand how it works.

Negative Real Interest Rates

   The primary mode of Financial Repression, and one that's been used in the United States for over a decade, is negative real interest rates (i.e. interest rates below the level of inflation).
    The Federal Reserve controls short-term interest rates with discounted money from its electronic printing presses, and then holds down long-term interest rates with huge purchases in the bond markets (also known as Quantitative Easing). Both actions have the effect of enabling the federal government to reduce existing debts, and make funding large deficits easier.

  However, there is a cost, in the form of a hidden tax, on savers who are not getting returns on investment that the market would normally pay them.

 Unlike income, consumption or sales taxes, the “repression” tax rate is determined by factors such as financial regulations and inflation performance, which are opaque -- if not invisible -- to the highly politicized realm of fiscal policy.

 At this point most people stop paying attention because their savings is rather modest, or their debt level is rather large. Thus negative real interest rates are a good thing in their eyes.

  But to stop paying attention here is like only watching the first half of a movie and then walking out, thinking that you know the plot. Or to put it another way, only reading the "For every action" part of Newton's law and skipping the "reaction" part. equal and opposite reaction

  Buyers of bonds aren't going to take financial repression lying down. They are going to shift their money elsewhere.

 One potential consequence of sustained financial repression is asset bubbles, as investors seek something better than negative returns on their money. “Without full-bore financial repression, would you have the equity markets at the levels they’re at in the U.S.? I doubt it,” says Mr. Mellyn...Because interest rates are kept artificially low, equities get reflated by investors seeking higher returns.
 So financial repression makes stock markets go higher. That sounds good, right? But good for who?
    Pension funds and retirees don't, or at least shouldn't be, investing in risky and volatile stocks. Their traditional sources of income, bonds and savings, are getting returns of less than the inflation rate. Thus, Baby Boomers can't retire. They have to stay in the workforce well into their golden years.


  "Well, I'm not a Baby Boomer. So I don't care because it doesn't effect me." But it does effect you. Baby Boomers not leaving the workforce means fewer jobs available for young people, in particular, good-paying jobs.

  What's more, the price deflation is most obvious in areas that benefit the wealthy, and price inflation is most obvious in areas that hurt the poor.


Wealth Inequality

  Normally when people understand that financial repression punishes savers and rewards debtors, they think this is good for the poor and bad for the wealthy. Which just shows that people don't understand how it works.

  In 2010, the top 1 percent of U.S. families captured as much as 93 percent of the nation’s income growth, according to a March paper by Emmanuel Saez, a University of California at Berkeley economist who studied Internal Revenue Service data.
    The earnings gap between rich and poor Americans was the widest in more than four decades in 2011, Census data show, surpassing income inequality previously reported in Uganda and Kazakhstan.
 If financial repression was punishing the wealthy then this shouldn't be happening.


   One reason it is happening is because the wealthy own the overwhelming percentage of stocks and bonds, while the working class have their wealth tied up in housing.

 For stockholders like Hemsley, the value of all outstanding shares has soared $6 trillion to $17 trillion since June 2009, the recession’s end. Even after a recent rebound, the value of owner-occupied housing, the chief asset of most middle- income families, has dropped $41 billion in the same period, part of a $5.8 trillion loss in home values since 2006.
    About 11.7 percent of middle-income families owned stock in 2010, down from 14 percent in 2007, according to the Federal Reserve. Almost half of the wealthiest 10 percent of American families owned stock in 2007 and 2010, the Fed says.
Put simply, financial repression is a wealth transfer from the working class to the wealthy elite. In other words, it is the opposite of what many people think it is who walked out of the movie halfway through. It is a repression on hard-working, working-class savers. It is a taxation on people like you and me, and public subsidy for the wealthy.

What the left hand giveth, the right hand taketh away

   So how big of an effect is financial repression having on the economy?
Consider what UBS' George Magnus had to say on the issue:

 "In the US household interest income from assets has dropped to below $1 trillion, compared to $1.4 trillion in 2008. That $400 billion drop is equivalent to a fall from 11.5% to below 7.5% as share of personal income, and, in passing, to the size of President Obama’s stimulus programme in 2009."
What Obama givith, the Federal Reserve taketh away.

 Let's be clear on something: lowering interest rates on money creation cheapens money. It is inflationary. Quantitative easing is printing money, and is also inflationary.
   Many might respond that "deflation is bad and must be avoided at all cost". But consider what deflation is - lower prices. When you go shop and you find a lower price on something, is your reaction "this is bad"? Of course not.
   If the price of food, tuition, and medical care was falling you would rejoice, not panic. Instead, food prices are on track to hit a new world record.

   Therefore, the Federal Reserves policies are inflationary. However, the Fed can't control where the newly created money goes, and that is the crucial issue here. Who is getting all this money?
   Or to put it another way, what asset price has gone up since 2007, and what asset prices have fallen? Then ask yourself who owns those assets?


  Consider the $1.1 Trillion of dollars of mortgage-backed securities the Fed has purchased through its quantitative easing policies. Some people are under the foolish idea that this is somehow supposed to benefit the "homeowners". But like every other Fed action, its designed to benefit the bankers.

 Let's say you own a portfolio of mortgage-backed securities and your pals at the Fed are willing to buy the garbage at full price, no questions asked: are you going to sell your few AAA-rated MBS, the good stuff, or are you going to sell them the absolute dregs, the MBS so stuffed with defaulted mortgages that you've never dared to even do a mark-to-market estimate of their real worth?
   You dump the worst of your portfolio, naturally, and so in effect the $1.1 trillion in MBS the Fed bought with newly created cash was probably worth (charitably) $600 billion at best.
 There are $9.7 Trillion worth of mortgages in the country. If the Fed wanted to, it could have completely wiped out the housing bust at the benefit of homeowners (ignoring the obvious problem of not helping renters).
   There is another added bankers benefit from this subsidy - to hide fraud.
 The Fed is now where mortgages go to die. Thousands of mortgages on homes that do not exist or on homes that have more than one “first” mortgage are now going to the Fed to disappear. Thousands of multifamily and commercial mortgages will be bought up as well. As this happens, trillions of dollars that have been amassed offshore will be free to come back into the US to buy up and reposition land, farmland, residential and commercial real estate and other tangibles.
   With documents shredded, criminal liabilities extinguished and financial institutions made whole, funds can return without fear of seizure.
 Imagine what else we could have done with $29 Trillion the Federal Reserve either loaned or backstopped for the banking elite.
 for example Cost of Iraq War: $3 Trillion; Cost of Solar Plants to Power all 105 million U.S Households: $500 Billion (April 10, 2008)
 Just 3% of the Fed money used to save the wealthy elite on Wall Street could have switched us over to a mostly solar-powered energy grid.

  This isn't to say that the our monetary policy is by its nature evil. What it means that trying to use monetary policy to paper over problems rather than undergoing real reforms that would upset the status quo is evil.

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Comment Preferences

  •  What the FED is doing is forcing investment into (4+ / 0-)
    Recommended by:
    gjohnsit, antirove, northsylvania, George3

    the stock market which imposes great risk on retiree's.  I have been asking what is forcing the market up(it is not fundamentals) and you just answered the question.  It is a bubble being created by the FED.

  •  One of your best posts, ever... (14+ / 0-)

    ...and it's important to emphasize the "rent-seeking," extractive policies that are being quite deliberately and covertly implemented, full throttle, by the status quo (with the full support of our government, I might add) as the unwashed masses fully buy into the charade playing out before us.

    Of particular shame is the housing/mortgage debacle, IMHO. It represents most of the net worth of our nation's middle class (as you rightly noted, the top 5%-10% of our society has most of their wealth invested the securities markets; for  the next 40%-50% of us, who own just 5%-10% of all maeketable securities, it's all about housing).

    Roughly half of our society lives paycheck-to-paycheck (and this doesn't include those of us who have no paychecks, at all).

    Meanwhile, the media touts "credit expansion," while simultaneously (totally) failing to note that private lending continues to diminish in terms of its overall availability, and it's now (goverment-funded/backed) student loans that account for the lion's share of the overall total of this deceptively pathetic meme. Effectively, it is this last truth which is continually downplayed in the MSM, which undermines (to a great extent) real long-term growth. At the end of the day, we end up with a nation stuck in indentured servitude, too poor to pick-up the slack, and unable to sustain a substantial rebound in housing.

    Concurrently, the monied class obtains more and more of the (distressed) real estate that does come to market (under these perverse conditions).

    The TBTF banks continue along (despite massive amounts of bullshit in the MSM to the countrary) becoming more and more powerful. Corporate profits and the stock market pumping become the exclusive focus of economic policies, despite even more government and MSM commentary to the contrary.

    And, generally speaking, the 99% continue to suffer greater and greater loss of quality of life while they're distracted by "reality t.v.," and an intelligentsia (look around this community for a brutal example of this) now totally in thrall to the 1%, walking off the veritable cliff that's already been created by the powers that be.

    It's the new normal. And, it's very, very least for those of us looking at life after November 6th...that are still around here to read this.

    Something's gotta' give. And, when it does, it's going to be very, very ugly.

    "I always thought if you worked hard enough and tried hard enough, things would work out. I was wrong." --Katharine Graham

    by bobswern on Sun Oct 14, 2012 at 10:32:07 AM PDT

  •  Great post even if I disagree with some of it (0+ / 0-)

    Inflation is caused by too much demand chasing too much supply. Increasing the amount of money can spur demand and cause inflation, but by itself increasing money doesn't cause inflation. With capital utilization still low we still don't have a real danger of hyper-inflation. We need a higher rate of inflation to create something our politics won't force banks to do, write down the inflated asset prices of many investments. Asset prices should be based on the amount of income they generate, with workers wages in a 15 year depression the "purchasing class" doesn't have the income to buy from the "supplier class". Higher inflation is a cruel and crude way of causing this. Some of the fear depends on if you think the Fed has the ability to drain excess capital out of the system. They claim to have a number of innovative ways of doing so.

    -1.63/ -1.49 "Speaking truth to power" (with snark of course)!

    by dopper0189 on Sun Oct 14, 2012 at 10:57:24 AM PDT

    •  The causes of inflation (4+ / 0-)

      It's amazing how many people have the wrong idea of what causes inflation. For instance:

       Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the long run. Consequently, there is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of money supply relative to the growth of the economy. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates
       Your idea of inflation is only partly right and only in the short-term.
         We are in the days of QE-to-infinity and unprecedented, global central bank intervention. So the antiquated ideas of inflation that you've written need to be retired.

      ¡Cállate o despertarás la izquierda! - protest sign in Spain

      by gjohnsit on Sun Oct 14, 2012 at 12:05:41 PM PDT

      [ Parent ]

  •  It seems most US folks don't think it can happen (5+ / 0-)

    here--3rd world style financial repression, and they don't feel they can comprehend what the big money geniuses are doing anyway, and assume the rich deserve whatever big profits they take--from being so hard working and innovative, and blessed by God and The Free Market--wherever that really is. They cannot imagine it to be true that there's be an organized effort by Wall Street's elite to defraud the majority of Americans via The Fed and boring banking institutions--clearly our leaders could never allow such a multi-Trillion dollar fraud to happen or we'd have to have some sort of national outcry and big trials or even a revolution.

    Obama keeps telling us to make him make the change we need--and we've gotten some things we needed, but we apparently have to try harder on a number of issues yet.   If we were to pull off a National Rally of 1% of Citizens, 3.5 million, and we showed up in Washington DC demanding full justice and truly reforming change to the banking system, we might be able to get some change.  Otherwise, John Q. Citizen just doesn't have the influence Wiford D. Lobbyist IV has.  If there's a seat at the table--the table and seats of decision which John Q. Citizen pays for with taxes and to which he imagines he's voted in the 'better than the worst choice' sorts of representatives--these representatives are still largely controlled by lobbyists and the elite preaching austerity (for the masses) and bigger profits for the rich (aka 'Job Creators'). If we have a mandate level election result, we can count on the 1% class to do all they can to block and overturn whatever is attempted to right the wrongs and restore real justice and enforcement. We have to follow up the election, when we're sick and tired of it, with  a large and relentless presence in DC to ensure those elected by us work for our interests.

    When life gives you wingnuts, make wingnut butter!

    by antirove on Sun Oct 14, 2012 at 11:12:44 AM PDT

  •  asdf (4+ / 0-)
     The country is horribly financially illiterate.
    Most pensioners could tell you that their savings are worth squat. The ones who survive have rental properties or savvy financial advisors. The run of the mill elderly woman with most of her money in savings could attest to the veracity of your diary.
    Interestingly enough, when I go off on anti-capitalist diatribes, my spouse replies that capitalism consists solely of investors expecting a reasonable return on investment, something that can not be accomplished under the present system unless you want to gamble. Many of the old ladies I know, and I count myself among them, were taught that gambling was either sinful or foolish, so they sit on their savings while the lights grow dimmer and the living room slowly, but inevitably reaches a temperature too low to be survivable.

    "There's a crack in everything; that's how the light gets in". Leonard Cohen

    by northsylvania on Sun Oct 14, 2012 at 02:15:32 PM PDT

  •  Romney keeps talking about overall (1+ / 0-)
    Recommended by:

    growth. Now I know that his aim is not for any sort of "redistribution" through taxation, so let's assume the rich keep what they have and the rest of us grow. Just in gross numbers, that means the economy would have to grow like 25%. This is not realistic, nor does it conform to any MMT theorems, or any other type of common sense application.

    We need to get the frame out there that if we say X is going to happen, then that means GDP/rate of growth has to be Y. Then maybe people would get the picture......or not, who knows, people are economically illiterate.

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