The Hidden Tax in Central Banks' Low-Interest Policy
Under the regime of the two-per-cent inflation standard, governments are levying a vast new tax. This shows up nowhere in public sector or private sector accounts and has so far created little if any resentment among those subject to its burden. Many live in the illusion that there is a continuing escape possible. This is a dream tax from the viewpoint of the collectors and their political masters.
As such the monetary repression tax (MRT) triumphs over the older and better-known inflation tax in terms of political efficiency. As regards economic efficiency, by contrast, both taxes are potentially devastating. For now, the new tax is more dangerous than the old, which may yet return in much more vicious form, as a huge confiscation in real terms of government debt and related monetary claims.
How best to define the MRT?
This is the amount by which the yield on “core” government bonds and bills (say US, Germany, France, UK, Japan) is depressed by monetary manipulations in the pursuance of “stable prices” as defined for the purposes of the 2 per cent inflation standard.
The power of the central bankers to levy this tax (on behalf of governments) depends on a combination of non-monetary forces which on their own would drive prices of goods and services downwards. During the past quarter century, globalization, digitalization, and new abundance in commodity supplies have together had a strongly “disinflationary” influence. Under sound money conditions prices would have been falling throughout – with the prospect of some price recovery into a subsequent era when these forces would be less strong.
Central banks in their defiance of the downward rhythm of prices by aiming instead for low inflation which they call “stable prices” have been able to steer interest rates to very low levels — and in the case of Europe and Japan, into sub-zero territory. Monetary Inflation has shown up in global asset markets but not according to the price data in goods and services markets as judged relative to the inflation target.
The monetary repression of interest rates has saved governments a tremendous amount of expense as their outstanding debts have ballooned. For example, under sound money the present US government deficit relative to GDP could be around 7%. That is reduced to the present 5% by MRT revenue running at say around 2%.
MRT is also collected by many private indebted entities including business and individuals. But the payments and receipts of MRT net out across the private sector economy globally. This is not the case for the government which is a huge net recipient of the tax.
It is a sick joke when economists of Keynesian persuasion advocate public works programs on the grounds that debt costs are now so low. To call a spade a spade: because you the citizens are not, in the main, aware of the MRT burden, we the central bankers acting for the government will fleece you even further by manipulating downwards the interest rates on new issues of public debt.
How are so many citizens unaware of the fleecing?
They believe that they can escape the MRT collectors by moving their funds into assets not directly subject to the tax for the most part. For example, they can eliminate government bonds from their portfolio and focus instead on a range of assets including real estate, equities, and credit paper. During the long asset inflation of recent decades, the rates of return on these have been fantastic, so why complain?
The best way of seeing through the illusions in this mindset is to consider the example of real estate in a tax haven and how the huge rents payable for the enjoyment of this mean that for most any escape is illusory from a long-run perspective.
Take the Principality of Monaco where the price of apartments is several times greater than similar real estate in neighbouring France. The premium on real estate in Monte Carlo reflects the advantage of residence there to a range of individuals globally who can take advantage of the freedom from income tax. The premium has ballooned in the past two decades as the demand for haven has soared and global monetary conditions have fueled speculative boom.
Lucky individuals who took up Monaco residence early and bought a home there can look back and say that far from paying a premium for tax freedom they have made fantastic gains. Yet this past good fortune should blind no-one to the inexorable logic of a grindingly high imputed rent to pay for the benefits of tax havens. Luck will run out. Great recession and crash would bring a slump in demand for haven real estate.
Let’s transpose this concept of “Monaco premium” to global asset markets.
Many investors have fled from assets subject to monetary repression tax (MRT), most recently from its manifestation in negative yields on $15 trillion of government debt (in Europe and Japan). In doing so they have bid up the price of assets which are not subject to the tax or only partially so – hence in recent times the surge of equities and high-yield debt. Further back in this asset inflation process residential and commercial real estate across a range of hot spots was top of the buy list.
MRT at present rates does not apply to older issues of government bonds so their price also surges. Rolling over 30-year T-bonds annually since 2000 has produced fantastic cumulative returns, in large part based on the climb of MRT rates. Speculative narratives in this climate of monetary inflation have brought huge gains in other major asset classes additional to those stemming from an increasing premium as a haven against MRT.
Yet the inexorable logic is the same as for tax haven real estate – this premium and its amortization or collapse over the long run will subtract from these cumulative returns and lower them into line with those on assets subject to MRT. The escape from MRT will be illusory except for a few. The negative yields now frightening so many are what to expect ultimately from haven assets.
Some investors share this view about the futility of escape, including those who have added to their holdings of government debt, replacing gaps in demand left by the exodus. The illusion prone investors by contrast are taking their cue from the huge rise in “Monaco premium” on such assets across recent years to expect perpetual high rates of return in their random walk down Wall Street.
High earnings yields flattered by raised leverage, a long “cyclical boom”, subjective value accounting, and likely transient monopoly power, all add to the illusions. Their spell remains untroubled by the ghost of past great inflations.