June 17, 2024

Why Bitcoin is needed: the problem of modern financial institutions - part 2

Our economic policies and financial management are clearly problematic, and this goes beyondpublicized crises.Let's turn our attention to the seemingly boring and abstract topics of government debt and inflation. Some of us watch the news regarding central bank interest rate decisions because these decisions directly affect our debt repayment obligations. But, very few of us watch the news regarding government debt or inflation. These issues are too far from our daily life and outside our sphere of influence, so it does not bother us. However, the impact of government debt and inflation changes our lives so profoundly that it is surprising why the media does not pay more attention to it.


Those of us who are privileged enough towell-known economic crises, such as the 2008 financial crisis and hyperinflation in countries such as Zimbabwe and Venezuela, are often considered one-time or rare events not to suffer from this. Anomalies. And, as a result, those of us who have a successful career in “well-functioning economies” do not realize the importance of monetary system deficiencies and how public debt, interest rates, and inflation are managed. But financial repressions regularly occur even in developed countries.

Financial repression is the worsta form of financial oppression because they redistribute wealth from the poor to the rich and potentially wasteful governments in the most inconspicuous way. This is possible with the regulatory and economic policies that take the form of prudential regulation, although, in fact, it is a politically incorrect, financially repressive approach.

Note translatorPrudential regulation is a system of rules of a state-authoritative nature, aimed at ensuring the stable and reliable functioning of the banking system as a whole, as well as protecting the interests of depositors through state registration and licensing of banking activities.

Financial repression

Financial repression is the term for regulatory measures leading to a careful diversion of funds from citizens' savings to governments in order to reduce the debt burden of the latter.

Financial repression has been carefully studied anddocumented, but since the end of the "era of financial repression" in the 1980s, they have become more gloomy. Basically, everyone forgot how the widespread system of financial repression, which prevailed for several decades (1945-1980s), played an important role in reducing the huge amount of public debt accumulated by many developed countries during the Second World War. Public debt was reduced due to the gradual transfer of wealth from citizens and investors to paying off public debt without any political consequences that could arise if austerity measures were taken.

State debt

US government debt

Financial repression was carried out usingA number of regulatory tools that governments have used and still use to pay off their debts by utilizing private sector savings, such as pension funds, etc.

How it works

Financial repression is carried out bythe creation of banking and regulatory mechanisms that lead to the fact that money owned by citizens falls into the banking system to alleviate the burden of public debt. In addition, policy and regulatory instruments ensure that the bulk of these savings will be directed towards public debt, and not other areas such as precious metals or offshore investments.

Simply put, governments borrow money fromcentral banks to finance their expenses (war, health, education, etc.) at relatively low interest rates. Central banks, in turn, provide these loans by borrowing from smaller banks at the same low interest rates. And those banks, in turn, minimize the impact of the low interest income that they receive from central banks by paying even less or not paying interest to the holders of bank accounts. The pure effect is that the central bank and its subordinate banks transfer the cost of these government loans to ordinary customers.

In addition, as already mentioned, toolsregulations ensure that the bulk of private sector savings will continue to go to public debt rather than other more profitable investment opportunities. For example, many pension funds are legally limited in how much money can be invested in offshore. Pension fund rules, for the most part, impose restrictions on how much you can invest in specific asset classes, but usually don't have restrictions on how much you can invest in government bonds. A global review of pension fund regulation in 2017 can be found here.

Political and regulatory instruments responsible for financial repression

Using private savings to pay off public debt is possible using the following policy and regulatory tools.

Explicit or indirect restrictions on interest rates, especially on government debt

These interest rate restrictions can be implemented in a variety of ways, including:

Explicit government regulation– Regulation Q in the United States prohibited banks from paying interest on demand deposits and limited interest rates on savings deposits.

Artificial interest rates for the central bank– often established at the direction of the Treasury or the Ministry of Finance when the independence of the central bank was limited or absent.

Additionally, the appearance and maintenance ofthe domestic market for government debt is achieved through capital requirements of banks to ensure public debt, as well as through prohibitive or predatory alternative measures.

This includes:

  • “Prudential” regulatory measures requiring institutions to provide public debt with their portfolios — pension funds have historically been the main option;
  • Operating stock taxes for investors also work directly on government debt;
  • Prohibition of operations with gold.

State restrictions on the transfer of assets abroad by introducing capital controls

Along with a steady increase in inflation, the above instruments facilitate the transfer of wealth from depositors in order to reduce the debt burden of the government.


When repayment of interest on statecredit below inflation, negative real (adjusted for inflation) interest repayment leads to erosion or liquidation of the real value of public debt. This document, published by the National Bureau of Economic Research, describes this economic phenomenon in great detail, as well as its enormous impact on society.

Negative real interest rates greatly reduce the burden of public debt because:

  • Payment of interest on government loans is very low compared to other rates in the market;
  • Inflation leads to an increase in taxrevenues for governments from capital gains tax, as well as VAT and income tax, which increase in proportion to the increase in wages.

Over time, the amount of debt repaymentCompared with tax revenue is significantly reduced. Negative real (adjusted for inflation) interest rates, of course, destroy the real value of public debt, but, at the same time, also lead to the destruction of the real value of the savings of individuals. The above policy instruments force investors to participate in this economic scheme, minimizing their ability to invest in other things that slow inflation, such as commodity or offshore investments.

Financial repression is sometimes called hiddentax free. The above policy instruments create a compulsory, absolutely regulated, controlled market where a combination of harmlessly low interest rates and slightly higher inflation rates direct private savings to reduce government debt in such a complex and unobvious way that the average voter never understands how it works, or even , never will be able to realize that this is happening. In the era of financial repression, enormous wealth was redistributed from investors with virtually no political consequences.

Factors Promoting Repression Stillrelevant today, but not so explicitly and not to the extent that it was in the era of financial repression. For example, interest-related prohibitions in Rule Q were lifted, and restrictions on the purchase of precious metals have largely disappeared. However, restrictions on offshore investments today still exist in many countries.

Financial institutions such as insurancecompanies and banks are motivated or even forced to keep a certain amount of government debt with low returns. In many cases, banks help eliminate public debt through government bonds with interest payments that are lower than inflation.

Banks, however, can avoid the negative impact on their income in the following way:

  • Use the deposits of their clients in bank / check accounts for issuing loans to the population at rates far exceeding the rates on government bonds;
  • Pay a lower percentage or, in general, not pay it to customers with checking accounts.

Banks may receive interest on loans(using the money of their customers) or invest in highly profitable assets (using the money of their customers) in order to not only eliminate public debt, but also to make a profit, no matter what.

Impact on society

The degree of influence of financial repression instrumentson individual savings depends on where the money is invested or where it is stored. If the money is stored in a bank account where interest is not earned, then they simply lose their value due to inflation. Money held in a risk-free account receives moderate interest rates. But, if real rates are negative, the value of this money is also undermined by the power of inflation.

Investors are constantly seeking income so thatmitigate inflation, for example, by investing in stocks. But, even after you were able to get income above inflation, your income can be taxed on capital gains, which to some extent immediately hit net income.

To give an idea of ​​how tangiblefinancial repression results for the country, let's look at the USA and the UK. In the era of financial repression, both of these countries, on average, were able to eliminate public debt by about 3-4% of GDP. In 1980, US GDP was about $ 2.86 trillion - 4% of this is approximately equal to $ 114.6 billion.

When it comes to stimulating the economy bymaintaining a healthy inflation rate of, say, 2% by lowering interest rates, central banks set in motion exactly what is needed to eliminate public debt. In particular, low interest rates combined with moderate inflation. Yes, 2% may seem harmless, but their impact worsens over time. For example, an investment of $ 1000, say, at 5% per annum for a 20-year period, according to the results, after 20 years, will be equal to, respectively, $ 2000. Nevertheless, the inflation rate of 2% per year will actually reduce the real growth of these investments by 32%, to approximately $ 1360.

Next financial crisis

The decade that preceded the beginningThe subprime crisis in the summer of 2007 led to record increases in private debt in many advanced economies, including the United States. Now, after this crisis, the national debt is becoming alarmingly high. According to the International Monetary Fund, global government debt to GDP is 250% - about 30 percentage points higher than it was on the eve of the 2008 financial crisis. The size of the risky leveraged lending market in the US has doubled to more than $1.2 trillion &#8212; from about $600 billion before the 2008 recession.

There are other factors (e.g. highcorporate debt level), which will contribute to the crisis. However, this does not detract from the fact that potentially wasteful government spending will be allowed to continue, because the mechanisms for subsidizing the liquidation of emerging debt obligations are invisible all the time. Only this time, the consequences will turn into not only a redistribution of wealth, but also a potential financial crisis, which will be much more severe than in 2008.

So when someone like Steve Mnuchinproclaims Bitcoin as an &#171;instrument of evil&#187;, and which (therefore) must be carefully controlled - it must in effect acknowledge that the potential for abuse of cryptocurrencies by bad actors pales in comparison to the abuse of monetary power by politicians and central bankers.

In the next article in this series, we will discuss what exactly makes Bitcoin a good alternative to &#171;evil&#187;.

Posted by: Irlon Terblanche