How Excessive Government Spending Leads to Financial Repression

The U.S. Senate passed a $1.1 trillion “bipartisan” infrastructure spending bill last week. Shortly afterward, just 50 senators passed an extremely partisan $3.5 trillion budget blueprint.

A good question to ask is where is the U.S. government going to come up with the money to pay for all that spending. The simple answer is the government will tax Americans as much as it can, then borrow the rest.

That’s where the problems begin. When politicians and bureaucrats decide where money will be spent in the economy, lots of that money gets wasted. That waste makes the economy much less productive than it could be.

When the economy gets less productive, politicians can’t collect as much in taxes as they were counting upon. So they have to borrow more to keep spending at the levels they want. But borrowing has its own cost that subtracts from what the government can spend: interest.

To keep that cost down, politicians have to count on low interest rates. If interest rates rise too much, they can no longer spend as much as they wanted because they have to pay more interest to their creditors. At least, not without having to raise taxes higher, or to borrow even more, or to default on paying back their creditors. Of these, defaulting is the last thing they want to do, because lenders make it harder for them to borrow more.

None of those are good options, which is why politicians often seek another path, called financial repression. They use their power and influence to artificially lower interest rates so they can keep borrowing and spending at the elevated levels they want. The longer that goes on, the worse all the problems become, and the more repression is needed.

Today’s Example

Writing in the Wall Street Journal, Joseph C. Sternberg describes how financial repression works in today’s world using more sophisticated terms than I just did:

Financial repression nowadays consists of several overlapping phenomena beyond the classic suppression of bank interest rates. A nonexhaustive list: more-intrusive management of assets and credit allocation in the banking system via reserve requirements, capital regulations and the like; a blurring of the line between fiscal and monetary policy such that monetary authorities subsidize the fiscal authority’s borrowing while the fiscal authority creates new credit subsidies for other parties; and any press release from Sen. Elizabeth Warren demanding a new regulation on this sort of lending or that sort of borrowing.

Sternberg describes the danger from the excessive spending ambitions of so many politicians and bureaucrats:

Because the debt must be repaid, a deficit borrows from future productivity to fund current spending—but this isn’t paid back only in future tax payments. Unfettered government spending also forces voters to pay via inflation and low returns on savings in the here and now.

More deeply, a discussion of financial repression prompts a reflection on productivity. The redirection of savers’ resources to politically favored “borrowers” (either directly via loan guarantees or more often indirectly via the disbursement of government grants raised via deficit financing) creates inefficiency and waste. If those loans were economically sensible—justified by a reasonable guess about the productivity the investment would create—the subsidy wouldn’t be necessary. Financial repression happens in the first place because the project the politician wants to spend money on is a productivity clunker, at the cost of fruitful investment in innovations that would permanently increase living standards.

It’s in this way, via rampant misallocation of capital and the attendant distortions of saving and investment, that Washington’s current spending binge won’t only borrow from the future. It will create a materially worse future, for which we all will pay one way and another.

The one thing we can fully guarantee that will result from more excessive federal government spending is more financial repression from Washington D.C. For too many politicians and bureaucrats, it is the only way they can satisfy their spending ambitions.

Craig Eyermann is a Research Fellow at the Independent Institute.
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