In today’s economy, good luck if you’re a saver.
No matter how much you have tucked away inside a general savings account, you are receiving pittance on your deposits. Right now, there are zero signals that policymakers will be raising interest rates above the rate of inflation. So be warned: rates running below the rate of inflation are here to stay.
But why are these benchmark rates so low anyway? Don’t they do more harm than good?
Rates are not established based on the free market. If the United States allowed market to dictate rates, they would likely be a lot higher than what the Federal Reserve and other central banks have installed.
The smartest men and women have cut rates to nearly zero – and, in some instances, they have been slashed to below zero – to stimulate the economy and cushion the blow from the coronavirus pandemic. However, due to this crushing monetary policy, the central banks have undertaken one of the most significant wealth transfers in modern history by taking from the poor and middle class and giving purchasing power to the upper echelons of society, mainly the government and Wall Street.
Put simply, this is financial repression in real-time.
Financial Repression: A Primer
In 1973, Stanford economists Edward Shaw and Ronald McKinnon coined the term “financial repression.” But what does it mean? Financial repression consists of multiple and revolving public policy maneuvers that essentially cause savers to earn returns below the inflation rate and enable financial institutions to offer cheap loans to governments and companies.
This is achieved by enacting one of several measures. These typically include capping or cutting interest rates, instituting high reserve requirements, maintaining public debt, and imposing capital controls. For the U.S., ZIRPs or NIRPs and carrying government debt are the two crucial factors in advancing financial repression.
But while it is easy to see this economic nostrum in the post-pandemic economy, financial repression can be found throughout modern U.S. history, particularly whenever an economic downturn arrives.
The Cure is Worse Than the Disease?
For the last 30 years, the solution to reverse a recession is to cut interest rates and introduce a zero interest rate policy (ZIRP) or a negative interest rate policy (NIRP). The idea behind these efforts, such as the many incarnations of quantitative easing, is that this would put more money into the economy by nudging consumers to spend more, banks to lend to small businesses, and investors to transfer more outstanding sums into the equities arena.
It does not always pan out this way. When Sweden adopted subzero rates several years ago, consumers did not substantially increase their consumption. Instead, they put their krona in the microwave, under the mattress, and delicious meatballs for years. The idea is that when an economy adopts negative rates, it gives off the impression that a financial crisis is pending or that the people are living in uncertain times.
But is the state’s supposed panacea superior to what happens after the downturn ends? Indeed, recessions usually unfold when there is too much malinvestment, resulting in the end of poorly performing and managed companies and assets being sold at rock bottom prices. But, ultimately, a market-triggered recession, led by a market-oriented correction, can lead to a prosperous economy since the marketplace is cleansing the incompetent money in favor of the smart money.
That said, no matter the circumstances, when rates are artificially controlled and suppressed, it is your average household that suffers the most. Retirees see their years of accumulated wealth become devalued. Middle-income households, often facing a plethora of costs, will see their earnings stretched. Young people will be discouraged from saving since they do not understand the objective when their purchasing power is diminished considerably from the very beginning.
The cure peddled by the interventionists generally leads to a situation whereby the low- and middle-income households take years to recover from these policy mechanisms. Politicians, bureaucrats, and hedge funds benefit at the expense of everyone else who had to endure lackluster returns on their bank deposits. However, the long-term consequences are what lead to permanent damage for anyone who is not close to the money spigot controlled by the Federal Reserve, Bank of England (BoE), or the European Central Bank (ECB).
The Money Spigot and Purchasing Power
When the central bank embarks upon a money-printing crusade, the parties with first access to this freshly created cash, usually governments and investment firms, benefit the most. However, once this newly-printed money travels through the system, it is everyone else who suffers at an obscene level. By the time the diluted currency reaches the cash register at your local supermarket, it has already been devalued, leading to a substantially reduced purchasing power of the dollars in your wallet and the change in your pocket. As Mark Thornton, a Senior Fellow at the Mises Institute, wrote: This is the cause of “bad government.”
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