Bernard Hickey: Japan tactics signal Great Repression

This week's slump in global stock markets is all about fear the world's largest economies, the United States and the eurozone, are about to slide back into recession.

More excited commentators are even saying this "triple-dip" recession will turn into another Great Depression. I'm not so sure. I think we're headed for what some people are calling "The Great Repression".

US, European and Japanese governments are indebted heavily, as are many households. The pressure of this debt is weighing on spending in these economies. Many governments and households are trying to dig themselves out from underneath, and there are three ways of doing this.

The first way is to simply stop spending and repay the debt as quickly as possible. Many households are doing this and some governments are being forced to do so by worried taxpayers. In markets such as Portugal, Italy, Greece, Spain and Italy, where governments aren't trusted or don't control their central banks, they are being forced to do it by the markets.

But there is a problem with repaying debt quickly. When governments both cut spending and increase taxes it can create a negative feedback loop. Some refer to this "paradox of thrift" phenomenon as a debt spiral. Reduced spending reduces jobs, which reduces incomes and taxes, which increases the burden of the debt as a percentage of income.

The second way is for debt to be restructured and for investors and bank shareholders to take losses in "haircuts". Instead, banks have mostly been bailed out by governments because of the fear that collapses would cause a depression.

The third way is for a country to inflate its way out of debt while suppressing interest rates. It's now clear that this is what the US and Europe are doing.

Japan has been holding interest rates down since the 1990s to try to keep it from sliding into depression. The Bank of Japan has set short-term rates at nearly zero per cent for almost 20 years while the state-owned Post Office and pension funds have been forced to buy government bonds with savings from an ageing population, keeping long-term rates low too.

Acclaimed US economist Carmen Reinhart says this tactic of "financial repression" was used in the 1940s to help keep interest rates low while inflation was allowed to rise above those interest rates. This reduced the real value of the debt and allowed the US government to dig itself out of debt after the Depression and World War II.

The US Federal Reserve has held its cash rate at nearly zero per cent for about three years. It has also printed more than US$1.45 trillion ($1.7 trillion) to buy US Treasury and mortgage bonds, both of which have repressed long-term rates.

Meanwhile, inflation has crept well above interest rates in both the US and in New Zealand. It's clear now that governments are comfortable with moderate inflation and don't want to (or can't) put up interest rates. That makes a floating mortgage rate attractive now.

Low rates help avoid a collapse but it means savers are being punished for the past sins of borrowers. Welcome to The Great Repression.