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June 2014 Restricted

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Accelerating Stealth Policy & Regulatory Responses

Gordon T Long

June 2014 Restricted
Copyright 2014 GordonTLong.com All Rights Reserved general@GordonTLong.com

Accelerating Stealth Policy & Regulatory Responses


HOW DOES IT HAPPEN? ......................................................................................................................................................................... 7

FINANCIAL PRIVILEGE ............................................................................................................................................................................ 9

CURRENCY CARTEL .............................................................................................................................................................................. 10

STRATEGIC MACRO INVESTMENT INSIGHTS ................................................................................................................................ 10

It is a Fools Game in Disguise!

June 2014 Restricted
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FINANCIAL REPRESSION GOES GLOBAL Accelerating Stealth Policy and Regulatory Responses

We wrote extensively about US Financial Repression in our 2012 Thesis paper entitled FINANCIAL
There are 6 hours of tapes available in our Macro Analytics library which includes over 350 slides on the

You can download the report by requesting a password at GordonTLong.com.
We also have a news coverage page on our site that publishes the latest Financial Repression news.

In 2012 we wrote that:
The larger the debts overhang of the public sector,
the weaker the health of the banking system,
the longer the balance sheet recession lasts and
the more foreign investors withdraw from domestic markets,
the more likely governments are to support Financial Repression.
We also said to expect a new era with:
More intrusive regulation,
Greater government involvement,
Less reliance on market mechanisms,
Tighter restrictions on international capital flows designed to produce a home bias and create a
captive domestic audience for public debt,
A distinct leaning towards gradually creating a captive buyer base that will hold more sovereign
debt through voluntary or coercive means,
Central banks that will venture into capital markets to maintain negative real interest rates,
Some central banks under political pressure will manipulate the exchange rate and potentially spark
currency wars between competing nations.
In addition, the idea of the central bank as an independent institution will be put aside to allow for
close interaction with the government.

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We have witnessed all of this since we wrote our 2012 paper.

So what is Financial Repression for those that may not be familiar?
In laymans terms it is about policy initiatives that take advantage of the phenomenon of Money Illusion.
That is
The tendency of people to think of currency in nominal, rather than real terms.
In effect Financial Repression leads to price increases - including incomes and taxes - while debts remain
nominally the same, thereby debt losing comparative value and decreasing in real terms.
Government Debts are essentially eliminated by means of inflation whereas citizens loose purchasing power
and are partially stripped of their financial means in the process.
It is a zero sum game. The losers loses are the winners gains.
Retirees and Savers (Baby Boomers) Are Robbed
With 75M Baby Boomers in the US about to retire at a rate of 10,000 per day and with approximately $84
Trillion in unfunded liabilities soon to be claimed, the US government has been forced to advance to Step 3
(which I will describe in a moment). The same problem is occurring in the UK, the EU and Japan. What I
often refer to as the Currency Cartel of the troubled developed economies.

Macro-Prudentially, the term Financial Repression is generally used to describe a comprehensive policy
regime put in place by the government to manage the domestic financial system with assistance from
the regulators by imposing tight restrictions on financial markets, intermediaries and services, often
complemented by capital account and foreign exchange controls to prevent evasion or currency speculation.
The governance framework of financial repression comprises all kinds of
Moral suasion,
Financial policies,
Qualitative and quantitative restrictions that determine price, quantity and entry conditions in
financial markets and affect the allocation of capital.
Such a pervasive regime of financial market interventions is often augmented by government instructions to
the central bank regarding the conduct of monetary policy.

Financial Repression is a STEALTH TAX with REGULATORY CHANGES & CAN often includes CONFISCATION
as it advances and becomes more entrenched.
Financial Repression is Stage 3 in the deterioration of an economic nation.
Step 1 we are all very familiar with.
STEP 1 Includes all forms of government TAXES, FEES, LICENSES, PENALTIES .
Step 2 is a little less understood and it is about inflation. Inflation is a TAX. Let me repeat that. Inflation is a
Tax enacted through intentional debasement of the currency by expanding it without correspondence direct
taxation or real economic expansion. It is the professional politicians favorite tax.
STEP 2 INFLATION (Pay in Tomorrows Reduced Currency)
Step 3 comes along when the nations debt has become too large for the nation to any longer easily hide or
politically manipulate.
STEP 3 REPRESSION (Steal from Savers via Negative Real Rates)

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In times of slow economic growth, policymakers options are grim.
Increasing taxes is not only unpopular; it can be counter-productive, given already-high taxation in many
countries. Public support for spending cuts is also difficult to win. As a result policymakers seek alternative
solutions many of which are classified as financial repression.

Financial repression occurs when governments take measures to channel to themselves funds that, in a
deregulated market, would go elsewhere. For example, many governments have implemented regulations
for banks and insurance companies that increase the amount of government debt that they own.
Consider the Basel III international banking standards.
Among other things, Basel III stipulates that banks do not have to set aside cash against their
investments in government bonds with ratings of AA- or higher. Moreover, investments in bonds
issued by their home governments require no buffer, regardless of the rating.

Meanwhile, Western central banks are using another kind of financial repression by maintaining negative
real interest rates (yielding less than the rate of inflation), which enables them to service their debt for free.
The European Central Banks policy rate stands at 0.75%, while the euro zones annual inflation rate is
2.5%. Likewise, the Bank of England keeps its policy rate at only 0.5%, despite an inflation rate that hovers
above 2%. And, in the United States, where inflation exceeds 2%, the Federal Reserves benchmark federal
funds rate remains at an historic low of 0-0.25%.
Moreover, given that the ECB, the Bank of England, and the Fed are venturing into capital markets via
quantitative easing (QE) in the US and the UK, and the ECBs outright monetary transactions (OMT)
program in the eurozone long-term real interest rates are also negative (the real 30-year interest rate in
the US is positive, but barely).
Such tactics, in which banks are nudged, not coerced, into investing in government debt, constitute soft
financial repression. But governments can go beyond such methods, demanding that financial institutions
maintain or increase their holdings of government debt, as the UKs Financial Service Authority did in 2009.
Similarly, in 2011, Spanish banks increased their lending to the government by almost 15%, even though
private-sector lending contracted and the Spanish government became less creditworthy. A senior Italian
banker once said that Italian banks would be hanged by the Ministry of Finance if they sold any of their
government-debt holdings. And a Portuguese banker declared that, while banks should reduce their
exposure to risky government bonds, government pressure to buy more was overwhelming.
In addition, in many countries, including France, Ireland, and Portugal, governments have raided pension
funds in order to finance their budget deficits. The UK is poised to take similar action, allowing local
government pension funds to invest in infrastructure projects.
Direct or indirect monetary financing of budget deficits used to rank among the gravest sins that a central
bank could commit. QE and OMT are simply new incarnations of this old transgression. Such central-bank
policies, together with Basel III, mean that financial repression will likely define the economic landscape for
at least another decade.

Let me give you a real world example to make this more personal:
As a retiree you save and put aside $500K for your retirement, expecting to get 6-8%
= $30K 40K
Financial Repression:
Get ~ Zero % nominal,
But Negative Real Rates (Step 2) and
Pay Taxes (Step 1) on any possible payout.
Forced Speculation (on Mispriced Risk) and Capital Gains IF you win

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As I learned in day 1 of my COLLEGE POLI-SCI 101 lecture:
Financial Repression is about Funding Government Debt & Obligations (On and Off Balance Sheet) Through
Inflation and Negative Real Interest Rates

The broad range of financial controls LEGISLATED represents a financial repression tax that directs
resources to the public sector. The financial repression tax may comprise both income from an implicit or
explicit tax imposed on the financial system and seigniorage from an inflation tax if the central bank is
subservient to the government and therefore unable to maintain price stability. These quasi-fiscal revenues
accrue to the government budget and relieve the need for painful fiscal adjustment. This makes financial
repression most attractive in times when public debt is high, and most effective in combination with a steady
rate of inflation that erodes the real value of debt and keeps real interest payments low.

We have seen this before in the US. Most recently after WWII but in a more subtle way then, than todays
more desperate actions.
After WWII US government Debt-to-GDP peaked at 120%. The government in cooperation with the US
Federal Reserve managed to:
Keep Rates and Yields low for longer,
Short rates adjusted for inflation were negative for a prolonged period,
Nominal Bond yields were kept below nominal GDP growth rates for most of the period until the
1980's - on average by 2.1% per year.
As you are no doubt aware, Bond yields should approximately equal growth in the long run according to
economic theory.

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In the three decades prior to 1980, inflation exceeded the long-term average in almost every year.
Consequently, nominal growth was relatively strong, exceeding nominal bond yields, while investors
did not react accordingly. Bond yields remained relatively low.
After three and a half decades, US public debt-to-GDP ratio had come down from 120% to 35% in
the mid-1970's and stayed there until the early 1980's,
Most of this effect is explained by the liquidation effect stemming from financial repression, around
3% per year

As I said before, Governments implement policies to REDIRECT FUNDS to the states coffers that in
a free market environment would go elsewhere.
They Require banks and insurers to hold government debt via capital requirements and restricting
the transfer of assets abroad, or by prohibiting or discouraging the use of alternatives, governments
create a captive domestic market for government debt. Method to do so include:
o Providing financing at low interest rates with sovereign bonds as only collateral allowed
(see the Long Term Refinancing Operations or LTROs of the European Central Bank) or
o Have central banks buy sovereign bonds directly on the markets (For instance the
quantitative easing campaigns in the United States).
Once this is done and the governments have managed to round up peoples savings, governments
move to reduce interest rates on government debt and deposit rates, bringing about negative real
interest rates across the board.
To complete the picture, inflation is unleashed or kept alive through quantitative easing policies and
currency devaluation, gradually reducing the sovereign debt but in the process also obliterating the
value of all savings.
It is essential to realize that there is an important difference between private and public debt:
Individual borrowers and corporations usually are required to provide existing assets to serve as
guarantee against their debt, whereas governments enjoy the privilege of being able to issue bonds
without any collateral. This allows countries to borrow money from citizens who, in return, receive a

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bond that promises repayment of the principal plus interest. Rather than providing collateral, the
state refinances rather than repays debts by printing new securities in order to replace the old ones.
This way public debt is simply passed on to future generations.
In turn this leads to a situation where financial institutions become the main purchasers of
sovereign bonds which they are not required by law to back with equity capital.
Ultimately, everyone benefitted from this system: governments found in banks keen and steady
customers for bonds, and in turn banks acquired fictitious assets that provided them with apparent
security on their balance sheets.
A lending spree of unseen proportions ensued. This could not go on forever and in 2009 the
illusion of risk-free debt created by governments around the world came to an abrupt end.
Operating like illegal Ponzi schemes, governments and financial institutions were paying off old
debt by constantly taking on new debt and deferring repayment further and further into the future
with each new loan. But all pyramid schemes are unsustainable and eventually collapse as will any
financial system that is based solely on debt.
The tools presently being used in the US to implement Financial Repression are:
The Management of Inflation Expectation through Statistical Measurement and Obfuscation,
Unregulated, Offshore, Off balance Sheet OTC Interest Rate Derivative SWAPS,
Zero Interest Rate Policy (ZIRP)
Quantitative Easing (QE1, QE2, QE3),
Repurchase Agreements (Repos) - Both through size and duration
Operation Twist,
Federal Reserve Transparency (Public Broadcasting) and Long Term Rate Targeting,
Inflation Targeting.
I need to note here that the: The Exchange Stabilization Fund (ESF) is used as a market intervention tool.
We will leave the mechanics of the day-to-day operations for another discussion where the use of Interest
Rate Swaps are used to control interest rates and harness the 'Bond Vigilante's'.

The papers have endless examples if you are paying attention:
ECB Seriously Considering Negative Interest Rates
Poland Confiscates Half Of Private Pension Funds To "Cut" Sovereign Debt Load
Europe Considers Wholesale Savings Confiscation, Enforced Redistribution
"Money Launderer Until Proven Innocent" - Italy Imposes 20% Tax Withholding On All Inbound
Money Transfers

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We need to understand the concept of

Repressive measures introduce financial privileges for the government that enable it to evade market
discipline or transfer private resources to the public sector in a quasi-fiscal manner. This is the case when
regulatory distortions:
Undermine the ability of financial markets to send disciplinary signals about economic fundamentals
and, in particular, the soundness of fiscal positions,
Persuade or force the private sector to allocate savings to the government at below-market interest
rates. (For example, the fiscal authorities may coerce domestic banks into helping to relieve public
sector funding constraints or supplying credit to state companies).
Claim the reserves from pension funds to fill their budget holes, thereby enjoying current windfall
income in exchange for taking over future pension commitments.
Confiscate private wealth and violate creditor rights to resolve a public debt overhang.
The treasury may also cajole the central bank into adjusting its monetary policy to favor the
government by capping its interest rates, buying large amounts of sovereign bonds in the market,
providing monetary financing, supporting fragile banks or generating excess inflation and higher
nominal GDP growth.
Repression may comprise controls over the free movement of capital in order to prevent investors
from escaping abroad.
The economic and distributional distortions of financial repression with a fiscal motivation are severe.
A diversion of private savings towards the public sector could crowd out private investment, and the
creation of captive domestic markets for government bonds implies a misallocation of international
Monetary financing and lasting episodes of repressed negative real interest rates sow the seeds of
future inflation and asset price bubbles,
The corresponding below-market real returns on bank deposits and bond holdings imply a mostly
hidden redistribution of income from savers and creditors to taxpayers and debtors,
Government decisions to expropriate private assets or to restructure public debt involve a
potentially disruptive wealth reallocation and hit financial institutions in need of savings and as large
owners of government bonds.
Persistently low interest rates or a treasury claim on pension reserves could lead to underfunded
pension systems, affecting the income and wealth distribution between generations.

1. Altogether, financial repression undermines incentives to save and invest, or stimulates savers and
investors to escape to the unregulated shadow financial sector or offshore.
2. Furthermore, the prospect of moral hazard on the part of sovereigns should be considered, as
privileged funding of the government reduces its incentives to undertake fundamental reforms.
3. The longer-term impact of such harmful financial repression on output growth is therefore likely to
be negative.
Notice the four developed countries who have the biggest debt problems the US, EU, Japan and
the EU

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They account for over 90% of the global reserve
currency holdings and about an equal level of
the $5T daily currency movements and trading.
I see them to be a cartel as they are acting in a
coordinated manner. They most evidently all
have Quantitative Easing and ZIRP in common!

From a Strategic Macro Investment Insights
perspective it is important that investors now
familiarize themselves with FX investments and
the currency crosses listed here.
These are tracked daily with technical trading
patterns through our Triggers.ca services.

Gordon T Long
Publisher & Editor

Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should
not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other
financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible
sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in
your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before
making important investment commitments.

Copyright 2014 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not
guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the
purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in
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based upon statements and information contained in any report, post, comment or suggestions you receive from him.