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Financial Repression

Oct 19, 2016

33

"So financial repression, in the way you mean it, is like when someone chokes you out in judo? You cut off the blood to the brain but you don't damage the airway. Boom! Out go the lights and you win."

"Well, not exactly. But I suppose you've got the spirit of it."

"Cool. I'm getting another beer."

You would have heard that discussion if you'd been down near Maltby Street in Bermondsey on Saturday afternoon. I was showing a visiting American friend around the markets there, having a Trappist beer or two. The thing with Trappist beers is you can't have very many, or at least not very fast. They can also lead to sudden loss of consciousness.

I'll come back to that in a moment. But speaking of brain benders, did you see what Otmar Issing told the journal Central Banking recently? Issing, the first chief economist of the European Central Bank (ECB) and one of the chief architects of the euro currency, prophesied doom for the project. Speaking of the ECB's €1 trillion bond-buying binge and attempt to spur growth in the eurozone he said (emphasis added is mine):

Realistically, it will be a case of muddling through, struggling from one crisis to the next. It is difficult to forecast how long this will continue for, but it cannot go on endlessly... One day, the house of cards will collapse.

Choked out by its own internal contradictions!

All it will take, according to Issing, is another crisis. And there is always another crisis. When it begins, Europe's governments will enter it with massive debt-to-GDP ratios, high unemployment and the same flexibility to cut interest rates that they've had since the inception of the common currency (none).

The ECB's governing council can change that last part when it meets on Thursday. But don't expect the council to raise rates. Europe's debt levels are too high (and growth is too low) to endure higher interest rates. The ECB could extend its bond-buying programme beyond March of next year. Or it could announce that new types of securities are eligible for its asset purchase programme.

But like the Bank of Japan, the ECB is reaching the frontiers of quantitative easing (QE) as we know it. Revitalised fiscal policy, in the form of much larger deficits, is coming. Markets don't seem to have fully appreciated this yet. When they do, you can expect rising bond yields... and falling government bond prices. How equities behave in that scenario depends on what equities you're talking about.


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On the prospect of falling bond prices, though, there was near consensus at the MoneyWeek Conference. There was also quite a bit of consensus at the conference that banking is a tough business to be in when interest rates are low. Take Deutsche Bank.

To the extent that Deutsche's latest troubles have been brought about by a proposed fine from the US Department of Justice (DoJ), the immediate cause of the anxiety is entirely artificial. The DoJ could end it all by announcing a $4.5 billion settlement. It's a political shakedown, not a liquidity or solvency crisis.

Still, some of Deutsche's biggest investors are getting a little nervous. On Friday, The Wall Street Journal reported that persistent worries about the bank's "thin" capital cushion have some of its largest investors wondering what the long-term plan is. According to the Journal:

Deutsche Bank AG's biggest shareholders, investment vehicles controlled by the Qatari royal family, have recently expressed concern about the threat of legal fines against the lender and whether it is adequately focused on its long-term strategy, according to people familiar with the matter.

The people briefed on communications involving Sheik Hamad bin Jassim al-Thani and his staff said he remains supportive of Chief Executive John Cryan and Deutsche Bank's chairman, Paul Achleitner. At the same time, the sheik lately has sought assurances that the bank is doing everything possible to resolve looming settlements with the U.S. Justice Department while also managing the business, the people said.

Keeping the Qatari investors pleased is a vital mission for Mr. Cryan. The bank has repeatedly said it doesn't need to raise fresh capital. But if its fortunes turn further for the worse, it mightn't have a choice-and the Qataris could be an obvious place to turn for new funds.

The last bit is the interesting bit, yet again. The Qataris may be on to something. It's hard to imagine that the German government, going into an election about a year from now, would allow serious doubts to fester about Deutsche Bank. If the bank needs to boost its capital by selling debt or equity to investors with deep pockets, the Qataris could get favourable terms with the presumption that the ultimate guarantor of Deutsche Bank is Deutschland.

Nobody knows how the rest of the EU will react if Germany breaks EU rules to bail out its own banks... after forbidding the same in Italy. My prediction: with fury and then with imitation. That is, if the Germans break the rules, all bets are off and Issing may be right.

Cards. House. Fall.

Which brings me back to financial repression and Trappist beer. Drinking the beer was worth the risk because I learned something about how normal people view financial repression. What did I learn?

First, you know a subject is on the "tipping point" of public consciousness when people who don't often think about money start asking you about it. It was one of the main themes at the recent MoneyWeek Conference. It's also the main theme of a conference I'm speaking at next week in Australia. But to be asked about it over beers by a friend who only thinks of repression in wrestling terms?

I explained to him that technically, artificially low interest rates favour large borrowers (governments) over savers (the governed). Financial repression is when the government uses central banks to keep interest low so large debts can be financed and large deficits can be accrued - without triggering huge contraction in GDP (depression) or a currency crisis (devaluation).

I suppose, though, my friend was right in his own way that it's like choking somebody out. You choke off someone's carotid artery and they're going to become compliant in the same way that a sack of wet turkeys is compliant - heavy and unwieldy perhaps; but largely deprived of the ability to make its own decisions and preserve its own welfare.

That's what all this business is about. The government becoming the prime creator of credit and the principal allocator of capital. That's more centralisation of the financial system. And in general, the more centralised you get, the less choice you get and the less free you are.

Please note: This article was first published in Capital & Conflict on October 17, 2016.

Dan Denning studied literature and history, moving to Agora Financial in Baltimore fresh out of college. Working alongside Bill Bonner and Addison Wiggin, he became managing editor of Strategic Investments. He then moved via Paris and London to Australia, publishing a book - The Bull Hunter - along the way, and opened Agora's successful office Down Under. He returned to London in 2015 and became the publisher of Fleet Street Publications' financial newsletters.

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