We Are All China Now
The West mocked Beijing’s financial repression for decades. Now it’s the future.
Grüezi!
1 The Great Repression
For decades, Western economists treated China’s financial system as an aberration awaiting correction. They tut-tutted state-directed credit. Pitied trapped domestic savers earning negative real returns on their deposits. Looked askance at capital controls preventing money from leaving. Were scandalised by banks required to hold government debt whether or not they actually wanted to.
The term for this was “financial repression.” The implication was that mature economies had moved past such things. Liberalised capital markets, independent central banks, interest rates set by supply and demand – this was where China was headed.
The irony of the next two decades is that the direction of travel will be reversed. It is “we” who will become China.
Not in the sense of adopting authoritarian rule or embracing state-owned enterprises (although even that no longer seems as certain as it once did).
But in the sense of deploying the tools that Beijing has long used to manage its unpayable debt burden – captive buyers, suppressed rates, the quiet erosion of savings. These are the measures that every aging, indebted democracy will quietly reach for.
Some already have. The others will follow.
2 Basel Instincts
Regular readers will know the numbers by now. Global public debt approaching 100 per cent of GDP. The Bank for International Settlements (BIS) is projecting 170 per cent for advanced economies by mid-century, absent a miraculous consolidation that no one believes will happen.
Populations eldering up everywhere – Europe, East Asia, the Americas – with fewer workers supporting more retirees, each living longer, each year of retirement costing more.
The entitlements these populations cling to are underwritten by assumptions that no longer hold. They will not be publicly broken. That would require a majority and, in our greying democratic world, no politician gets one by telling pensioners their benefits will be cut.
Instead, the promises will be kept in form and adjusted in substance. Paid in full, in nominal terms, in currencies whose purchasing power has been quietly arranged to make the debt sustainable.
This is not a prediction. It is a description of the only path that doesn’t require either political courage or systemic rupture.
3 Process of Elimination
There are, in theory, five ways to get out of debt jail:
Growth,
Austerity,
Default,
Inflation shock,
Financial repression with moderate inflation.
The first is every politician’s prayer. The second is electoral suicide. The third is unthinkable for reserve-currency issuers. The fourth destroys the very credibility central banks need to function.
Which leaves option five. Not a choice exactly, but the absence of alternatives.
Financial repression means keeping interest rates below inflation for extended periods, so debt erodes in real terms whilst nominal obligations are honoured.
It means regulatory frameworks that push domestic institutions into government bonds. It means ensuring savers have nowhere else to go.
There is, of course, a historical precedent. After WW2, US debt-to-GDP fell from 106 per cent to 23 per cent over three decades. Economists Carmen Reinhart and Belen Sbrancia calculated that the “liquidation effect” – reducing debt through negative real rates – ran at 3 to 4 per cent of GDP annually throughout the Bretton Woods era.
Savers paid a tax that didn’t require a vote. The promise of repayment was honoured; the substance was not.
The difference now is that we pretend this is not the plan.
4 The Number from Nowhere
Consider the 2 per cent inflation target that central banks treat as sacred.
It was invented in 1989 by the Reserve Bank of New Zealand. The governor, Don Brash, needed a number that sounded credible for a new policy framework. He picked 2 per cent – low enough to claim price stability, high enough to give room for error. There was no deep economic reasoning. It was, in Brash’s own later telling, somewhat arbitrary.
But it spread. The Bank of Canada adopted it. Then the Bank of England. The ECB. The Federal Reserve, belatedly and reluctantly. By the 2000s, 2 per cent had become a global orthodoxy, defended as if it derived from economics’ first principles rather than the expedience of a press release issued by a central banker in Wellington.
Now there is quiet academic discussion about whether the target should be 3 or 4 per cent. Economists call their reasoning “technical.” Higher steady-state inflation gives central banks more room to cut rates in recessions. Olivier Blanchard at the IMF floated this in 2010. Others have followed.
The general public would call it robbery. Higher inflation erodes debt faster, as corrosive as salt water on seaside railings. At 2 per cent inflation with 2 per cent real rates, debt compounds. At 4 per cent inflation with 2 per cent nominal rates, debt begins to disappear. The difference over two decades is the difference between crisis and manageable decline.
No central bank will announce a higher target. To do so would be to admit the framework is not about optimising outcomes but about managing a transfer that cannot be made explicit. The target will stay at 2 per cent. The outcomes will run higher. Everyone will express puzzlement about why inflation is so persistent.
5 Nostalgia Isn’t What It Used to Be
Perhaps a return to the glory days of the post-war period would do us all good? Perhaps financial repression could be repackaged as nostalgia, a singalong to the hits of yesteryear in the global policy dementia village.
Something is different today though. What has changed since the post-war era is the plumbing – and the plumbing no longer drains, but floods.
Before 2008, most government debt was held by banks. Now it’s a motley group of pension funds, insurance companies, hedge funds, and money market funds. “Non-bank financial intermediaries” in the industry jargon. Their holdings rose by 74 percentage points of global GDP between 2008 and 2023, whilst bank holdings rose by only 17.
The risks are different and in some ways worse. Hedge funds now hold roughly a trillion dollars in leveraged bets on US Treasuries alone, double pre-COVID levels.
The returns on these trades are tiny, and the borrowing required to make them worthwhile is extreme. It’s not unusual for funds to borrow 50 dollars for every one of their own. And those doing the lending demand almost no collateral – meaning there’s nothing to hold back the borrowing until everything goes wrong at once.
Pension funds face different vulnerabilities. To manage their risk, they contract with banks to place bets, essentially, on interest rate movements. These contracts require the pension fund to put up cash when bond prices fall. To raise that cash, they sell bonds. Which pushes bond prices down. Which triggers demands for more cash. Which forces more selling.
How does that look in real life? The UK bond crisis of September 2022 showed precisely how this plays out. Liz Truss, a kind of cosplay Margaret Thatcher, came to Downing Street promising Britons unfunded tax cuts. Bond prices collapsed and British pension funds faced a doom loop.
The Bank of England had to step in, announcing it would buy bonds on “whatever scale is necessary” – whilst simultaneously raising interest rates to fight inflation. Trying to brake and accelerate at the same time. Pension funds may have lost over £500 billion.
The Bank had a choice: fight inflation or save the bond market. It saved the bond market. Inflation kept rising. The politicians were replaced.
The lesson both parties drew was not about inflation or central bank independence. It was about fragility.
Politicians cannot tell pensioners the truth. Pension funds cannot avoid holding government debt.
Both are locked into the same system – and when it wobbles, everyone falls.
6 Kintsukuroi Economics
This is what to expect. Not one dramatic sovereign default, but a series of localised blow-ups: a minor pension fund crisis here, a money market run there, a hedge fund unwind somewhere else. Each individually “contained” by central bank intervention. Each intervention reinforcing the implicit guarantee. Each guarantee encouraging more of the behaviour that made the intervention necessary.
The March 2020 Treasury market seizure was a preview. As COVID hit, hedge funds rushed to unwind bets they’d borrowed heavily to fund, selling US government bonds into a falling market. Dealers couldn’t absorb the flow. The Federal Reserve had to step in with unlimited purchases – of the very assets that were supposed to be the safest in the world.
The cumulative effect is that central banks become the buyer of last resort for government debt. Not formally, but functionally. The BIS warns about it. The financial press writes columns about it. Everyone knows it. And the knowing changes nothing, because the alternative – letting a sovereign bond market seize up – is unthinkable.
Japan has run this experiment the longest. Government debt is 230 per cent of GDP. The Bank of Japan holds 40 per cent of outstanding government bonds. Yields have been pinned near zero for a generation.
There is a Japanese art for making broken things beautiful. Economic kintsukuroi was not chaos and catastrophe; it was elegantly engineered stagnation. The young withdrew. The old collected pensions in a currency that bought less than it should have.
Japan is sometimes cited as proof that high debt does not matter. A better reading is that Japan shows what choosing slow decline over painful restructuring looks like: a generation of stagnation, companies kept alive by cheap credit rather than allowed to fail; and savers earning almost nothing.
An economy that avoided crisis but, in the repairing, avoided renewal.
7 Full Faith and Discredit
Democracy will continue. It will be the name for a system that maintains the form of its commitments whilst adjusting the substance. Democracies will tax without legislating, transfer without voting, and devalue without defaulting.
Central bankers will express concern about inflation whilst providing the liquidity that sustains it. Politicians will promise fiscal responsibility whilst running deficits that require more borrowing. Regulators will warn about leverage whilst creating frameworks that encourage it.
Everyone will blame global factors, supply shocks, structural impediments. Responsibility will be dispersed. Effects will accumulate like sediment.
The public will not be told why their money buys less, why their children cannot afford houses, why the promise of prosperity has quietly curdled. They will look for someone to blame.
They will suspect immigrants, elites, the other – anyone but a system designed to be unaccountable.
This is the quiet tax – the price of promises that cannot be kept as made, levied in purchasing power rather than legislated rates, and collected so stealthily that the taking is never quite visible.
Financial repression worked after the war because democracy was managed: limited information, elite consensus, populations who trusted institutions and asked few questions.
Those conditions no longer hold.
The same policy must now operate on people who are sceptical, networked, and angry – who sense they are being cheated even if they cannot name how.
The coming decades will test whether you can run a quiet tax on a noisy democracy.
China’s answer is that you cannot – which is why it has never tried.
Thanks for reading!
Best
Adrian
terrific, the last paragraph in particular. but can a fratiouss democracy adopt a policy of finanial repression except in war -- or, perhaps, dramatic climate change?