Financial repression poses a serious threat to your wealth

Financial repression poses a serious threat to the wealth of millions of savers and investors, and it is likely to be a dominant feature within the financial landscape for at least the remainder of the decade. This article examines what financial repression is, and how savers and investors can protect themselves from it.

What is financial repression?

Financial repression is a collection of government policies which include:

  • The creation of an environment of negative real interest rates. I.e. interest rates that are below the rate of inflation.
  • Government ownership or control of domestic banks and financial institutions.
  • Requiring domestic banks to hold government debt via reserve requirements.
  • The introduction of capital controls.

Financial repression works by keeping capital captive and then subjecting it to rates of return that are below the interest rate payable on investments such as government bonds or cash in the bank.

Why governments like financial repression

Between 1945 and 1980 financial repression became the policy of choice for many nations struggling with huge public debts, and it’s a policy that’s being pursued by Britain, the US and many other countries again today.

Financial repression allows governments to erode the real value of their debts. It also allows them to issue debt at very low interest rates thereby keeping debt servicing costs to a minimum.

Unfortunately, savers or others with low yielding investments are also affected by financial repression since it erodes the real value of their savings. Because of this, financial repression has also redefined the conventional notion of risk.

Risk free is no longer risk free

As a result of financial repression, investments that were previously seen as being “risk free” are no longer risk free. In fact, investments such as cash in the bank, or a savings account, that are traditionally thought of as “safe investments” are actually just the opposite. They are in fact guaranteed to lose you money, often at an alarming rate.

Financial repression at work

This real world example shows how financial repression destroys the value of savings, however it’s important to remember that it is equally effective at destroying the value of debt.

An investment of £10,000 in a typical savings account such as ING Direct, (which yields 0.50% gross per annum) would return £50 per year before tax. Therefore at the end of the year the nominal value of your investment is £10,050.

The problem however, is that in real terms, i.e. adjusted for inflation, currently 3.1%*, your savings will only be worth £9,740. That’s because you’re actually getting a real rate of return of -2.6%. Therefore after 5 years your statement will read £11,369, but you will only be able to buy £8,766 worth of goods and services.

*I like to use the Retail Prices Index (RPI) because it’s a more complete measure of inflation since it includes mortgage interest payments.

It’s important to realise that in an environment of financial repression the nominal value of assets quickly loses its relevance. What matters is their real value, i.e. their value adjusted for inflation.

How to combat financial repression

In an environment of financial repression those with wealth must accept that if they choose to leave their money on deposit at a bank, or in a savings account, they will lose money to the ravages of inflation. There are only two alternatives. Spend the money, which the Chancellor openly admits that he would rather you did as it would then add to GDP, or consider putting your money in other investments that are traditionally considered higher risk.

Gold is one investment that has benefited from negative real interest rates that persist across much of the globe. It is also one of the main beneficiaries of all the money printing and bailouts that we have seen since the global financial crisis began, and over time I believe it will continue to provide protection from the widespread policy of financial repression.

The search for yields

In addition to the protection provided by gold, I also like companies (and funds) that provide regular income in the form of quarterly (or even monthly) dividends. In particular I like those companies that have a long history of paying a dividend (Coca-Cola for example has paid a dividend every year since 1920) and of increasing the payout over time.

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