Many have been outraged, and justifiably, of the European Union and the busted nation of Cyprus’ efforts to tax the bank deposits, guaranteed or not, of Cyprus banks’ depositors. As columnist Thomas Sowell notes: “The economic repercussions of having people feel that their money is not safe in banks can be catastrophic. Banks are not just warehouses where money can be stored. They are crucial institutions for gathering individually modest amounts of money from millions of people and transferring that money to strangers whom those people would not directly entrust it to.” (Read)
What many observers of the Cyprus and EU outrage don’t understand is that millions of bank deposit holders, including in the United States, have already suffered a significant loss in their savings, enacted through policies supported by governments and major banks. The astute blogger, Buttonwood, in The Economist (read) calls it “the financial-repression levy.” That is when bank financial instruments, such as certificate of deposits, are set so low that inflation significantly outpaces the deposit’s earnings.
Buttonwood writes: “… savers in other developed countries have also seen a hit to their purchasing power in the form of negative real interest rates, a type of financial repression. The clever thing about this approach is that it erodes the purchasing power of savers’ capital slowly but steadily, rather than dramatically, and thus tends not to provoke much protest.” … As the blogger notes, from 2009 to 2013 U.S. investors gained only 3.2 percent in money invested in a six-month CD. However, inflation ate up more than 6 percent of earnings. So, investors lost money.
How does that help the banks and nations? For a bank, having to pay a less than 1 percent interest on a CD provides a lot more potential return on its investments with the money it gathers. For nations, consider the U.S. The Federal Reserve’s policy of quantitative easing is, as Sowell explains, basically creating money out of thin air. The Fed floods the economy with cash via bonds that it pays for by creating money. That leads to inflation, which easily outpaces the banks’ interest rate earned by depositors.
Obviously, this is a different type of “levy,” in that unlike Cyprus, investors losing dollars in CDs, etc., are not having their cash forcibly extracted. And every CD or money market fund investor can, if they wish, transfer their bank investments into mutual funds or other investments that tend to yield higher returns over 10-, 20-, or longer year periods.
Except, as Buttonwood notes, investors aren’t doing that. Too many eschew stocks and mutual funds, spooked away by the recent recession and periodic market corrections. He notes that two generations ago, the last time in Britain there was a major “financial-repression levy,” there was no move toward equity investments. People simply rode out the inflation losses, or increased their bank-type savings.
Financial repression has a long history. It’s always going to be here. It’s a subtle way for nations to cut their debt and for banks to recover fiscal health. The onus is on the average investor to be aware of how inflation cuts into savings and move some money to riskier but usually higher-yielding mutual funds.