Creative Deficiting

“History shows that when governments grow desperate to finance deficits, they get creative,” writes our inter-office hoodlum Ralph. Ralph just got back from a CFA Society meeting at which Russell Napier, a prominent stock market historian, shared his latest thoughts.

“During World War II, the U.S. government needed investors to buy an unprecedented amount of Treasury bonds. Commercial banks loaded up on Treasuries, which limited the amount of credit that could be granted to the private sector. It may have been the patriotic thing to do, but the real returns from war bonds were very poor. Napier said, ‘That’s the type of society [the U.S. and the U.K.] had to run to sustain our government debt. And I’m suggesting to you that these are exactly the sorts of things we have to look out for in our future.’
“Financial suppression is the process of forcing private sector savings into public sector debt. Most investors will tell you that this is impossible. But Napier ticked off two potential tools the government could use to strong-arm investors into Treasuries:
~Capital controls: An example of this comes from the U.K. in the 1970s. For most of this decade, the yield on U.K. government bonds was below inflation. The government wouldn’t let investors take money out of the country.
~The ‘Buffett tax’: Political leaders would say, ‘We love capitalism. It is the best thing America has ever had. And we would really, really like to promote it. And the best way we can promote capitalism is to get all you capitalists to invest with a long-term holding period.’ The idea would involve a 4% ‘transaction tax.’ This effectively forces shareholders to engage more deeply with corporate executives, rather than trading shares aggressively. The authorities would say, ‘This is a wonderful thing because Warren Buffett does it. And if Buffett does it, it has to be good. So as of tomorrow, we’ll have a 4% “Buffett” tax for the trading of all financial instruments except for government debt.’

“Napier says the government can’t get away with inflating away its debt in a free market. If it were attempted in an aggressive fashion, yields would soar, making the process self-defeating. So the government will make the Treasury market a ‘less free’ market. In other words, it will stack the deck in favor of Treasuries, to the detriment of all other financial assets.”