Repression and memory at Pimco

First Bill Gross called for a bond market turkey shoot and bet against U.S. government bonds just before they staged a big rally. Now one of his functionaries, portfolio manager Scott Mather, is warning about “financial repression.”

That sounds vaguely Freudian, though it actually refers to the process of holding down interest rates to help pay down ridiculous government debt loads. It is, all things considered, a reasonable response to a bad situation. But Pimco won’t let that stop it from a bit of hyperventilating.

First, Mather warns that financial repression is “primarily a tool to redistribute wealth from creditors (citizens) to debtors (governments) to the detriment of creditors, fixed income investors and savers.”

This is true as far as it goes. Consider that Exhibit A, the Fed’s low interest rate stance, has siphoned perhaps $100 billion or more out of savers’ pockets in recent years. Even so, all policies have their pros and cons, and you can make the argument that propping up the banking sector is well worth that hit.

Now for the part that is not true as far as it goes. Mather wants us to see that the United States isn’t the only global repressor, and that as the chains of repression stretch across the globe the effects become unpredictable. He even manages to give the process a catchy name, the “global circle of financial repression”:

We are seeing a circular dynamic with developed and emerging economies both expanding use of financial repression. With an eye to boosting economic growth while keeping debt funding costs low, developed country central banks are keeping interest rates low and have done more extreme measures, including direct purchases of government debt. These activities, when coupled with developed world trade deficits, have contributed to pressure on EM currencies to appreciate.

EM countries then resist this appreciation by directly intervening in currency markets and accumulating advanced economy currency reserves, namely the U.S. dollar, which are then reinvested in mostly developed world government bonds, helping to push down developed nation interest rates further!  This is a global circle of financial repression in which policymakers are influencing prices of bonds and currencies as well as interest rate levels. 

The main problem with this account is that it presents the emerging market central banks as responding to the actions of the Fed and European Central Bank and others – when it is clear that the reserve accumulation of China and Brazil and the rest of the poorer countries came first, and for their own reasons.

It was their accumulation of dollar reserves following the Asian crisis of the late 1990s, after all, that prompted Ben Bernanke to come up with his global savings glut explanation of the U.S. housing bubble half a decade ago. Even before the Fed and ECB opened the monetary floodgates in 2008, China was building up trillions of foreign reserves, largely because the process helped goose domestic employment. So who’s repressing whom?

That’s not the only shortcoming of the financial repression story. The other one is that while bondholding “citizens,” in Mather’s word, do take a hit when governments try to inflate away their debt burdens, that sacrifice stands in stark contrast to what we might call the government haircut problem.

That affliction, seen most debilitatingly in Greece and Ireland, keeps governments from forcing bank bondholders to share in the losses caused by their bad lending decisions, even if the difference has to come out of taxpayers’ pockets. Why?

Because you can’t risk the contagion that would surely ensue if bondholders had to face the market discipline they are so fond of applying to others. This, regardless of new rules and stern pronouncements, is the observation that leaves so many of us believing we will have bailouts forever — or until we run out of money, whichever comes first.

That condition, rather than “financial repression,” is the real problem for citizens nowadays, whatever Pimco might say.