DESTA VEZ É DIFERENTE

This time is different

Carmen M. Reinhart

Keneth Rogoff

How likely is financial repression?

Martin Wolf

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First comes financial crisis; then comes sovereign debt crisis; then comes financial repression. This is the view of Carmen Reinhart, co-author of This Time is Different, the masterly study of financial crises through the ages. I recently had a fascinating conversation on this topic with her, here in New York, where I have been living since the beginning of April.

So the question for the exchange is: how likely is financial repression? What forms might it take? Might this even be the end of the era of globalised finance?

Her argument is very plausible. It is also supported by the history of both advanced and emerging countries. First, governments encourage credit expansion by the financial sector. As a result, a mountain of bad debt is piled up. Then, at some point, comes panic. At this stage, governments nationalise the liabilities of their financial sector and, more important, find their revenues collapsing, along with the economy. Huge fiscal deficits then emerge and public debt starts to soar. Of course, frequently, governments short-circuit this financial route and simply run huge and unsustainable fiscal deficits in good times. Either way, an unsustainable fiscal position leads, sooner or later, to a sovereign debt crisis, particularly if governments borrow in foreign currencies, short term, or both (as often happens, in such situations).

What do governments do when it becomes expensive to borrow? They promise to mend their ways, of course. But, by now, it is often too late: nobody believes them. So they tell the central bank to buy their bonds, which starts a run on the currency. Pegged exchange rates collapse and floating exchange rates fall. Inflation becomes an imminent threat.

At this point, desperate governments look for ways to force institutions to hold their bonds, willy nilly. This is the point at which financial repression begins: banks are forced to hold government bonds, for “liquidity”; pension funds are forced to hold government bonds, for “safety”; interest rate ceilings are imposed on private lending; to prevent “usury”; and, if all else fails, exchange controls are imposed, to ensure nobody can easily escape from such regulations.

So how likely are such measures in the advanced countries that are now in difficulty? How easily would financial markets find it to evade them? What might governments do in response? Could financial globalisation even disintegrate? This is a subject on which I plan to write a column soon. I look for comments on this theme.