State budget consolidation is a noble goal, but – as Bertolt Brecht already stated in another context – “the world is just not like that”. But the world will not remain as it is now. Therefore, markets must be prepared for the fact that an old specter could reappear, probably first in the US: financial repression with additional foreign trade elements, derived from the “Mar-a-Lago Accord” considerations.
The United States of America is currently in a shutdown because the government has not yet succeeded in getting a budget for the fiscal year 2026 or at least a transitional budget through parliament. One of the stumbling blocks is certainly that, despite all the campaign promises, the projections for government debt predict that they will continue to grow unchecked. Despite increased customs revenues, the annual deficit is close to the 2 trillion US dollar mark, i.e. 2,000 billion US dollars, and even if 400 billion customs revenues can actually be achieved annually in the long term, they do not seem like a solution, at best a reduction. The annual deficit is likely to remain between five and six percentage points of economic output, in a period without recession.
The US is not alone. In France, the Barnier, Bayrou and Lecornu governments have failed in the last 15 months to pass a budget for 2026 that would push the deficit below the 5 percent mark in the long term, and in the second attempt, Lecornu has already announced that the pension reform will be put on hold until 2028. In Japan, cautious austerity measures led to the resignation of the prime minister, in Germany they did not even try, and the United Kingdom changes its finance ministers faster than its heads of government.
Reasons for new government spending are quickly found: the infrastructure is partly dilapidated, the energy transition and security require state support, defense is currently the first political priority and much more.
But can this just go on like this? The answer is a clear no, at least not for everyone.
More important than the absolute amount of new debt is the amount of current or accumulated debt to economic output, measured by default in terms of national product, and the interest burden that this debt entails for the national budget. In a widely acclaimed 2011 book “This Time is different”, the scientists Carmen Reinhardt and Kenneth Rogoff argued, among other things, that beyond a threshold of 90 percent accumulated national debt to the national product, the state’s ability to act is at stake. The defined level of the quota was questioned in heated discussions, also with regard to the methodological derivation, and later interpreted more flexibly. However, the core remains that the state loses its ability to act as debt increases and that political efforts are needed to get out of this situation. Debt has increased dramatically in the last 15 years, not only in absolute terms, but also relative to economic output, and now the majority of industrialized Western countries are in the three-digit range of debt ratios.
While in the second decade of this millennium these undesirable economic developments were masked by the low interest rate phase (in some countries such as Germany even a negative interest rate phase), this phase with the inflation surge and the return to more normal interest rates has been over for several years.
There are options for action to reduce these sovereign debt ratios, but they differ in the difficulty of political enforceability.
On the one hand, one could start directly on both sides of the budget: higher taxes or lower expenditures are direct decisions to make budgets more balanced. But you have to persevere. And in all elections that take place every two to four years, the incentives for politicians to do so are low. The list of those who have heralded their political end with the attempt to consolidate government balance sheets is too long.
The most popular option, because if successful, also best for the popularity of politicians, is the way through higher growth. Higher growth creates higher tax revenues and also lower social spending, and thus contributes to alleviating the debt situation from two sides: budget consolidation and an increase in economic output. This is currently the focus of the new administration in the USA. In Europe, on the other hand, I can see few concepts for promoting growth, growth is de facto financed by additional government spending and deficits on credit. However, the growth strategy is only successful if, on the one hand, nominal growth is higher than growth in new debt. In addition, the side effects of higher growth must be kept under control so that the higher tax revenues from growth are not eaten up by higher interest costs on pent-up debt.
Financial repression as a miracle cure?
This opens the door to a “painless” solution for political decision-makers, at least at first glance: financial repression. The term is not new, nor is it unambiguously defined. Depending on the author, a broad bundle of measures can be included. Most importantly, various measures are used to keep interest rates on government debt lower than they would be under pure market forces, especially real interest rates. The relative financing costs of the state are thus artificially depressed, the price is an inconspicuous, gentle, creeping reduction of real assets, or a cap on the growth of wealth resulting from nominal interest investments.
Just as the term financial repression is not clearly defined, the same does not apply to the measures associated with it.
This can happen through capital controls (although these are rather “outdated”), through continuous bond purchases by the central bank, or sometimes envisaged purchase programs are sufficient. In addition to or alone, there can also be an active “yield curve control”, i.e. the central bank caps interest rates upwards across the entire yield curve. Banks and insurance companies can be “incentivized” by regulatory provisions to buy bonds of the respective nation state (liquidity, solvency rules, capital crediting and the like). Some authors also include a change in the central bank’s inflation, which is accepted as stable in monetary value, to these measures, which at least indicates that monetary devaluation is desired to a limited extent, for example from the standardized 2 percent target towards 3 to 4 percent accepted inflation.
The aim is to counteract the possible negative consequences of a growth policy, namely higher interest rates, and to de facto bring about a creeping devaluation of government debt and thus restore the state’s ability to act. This is not a one-off feat of strength, but a long-term operation.
History knows different phases of financial repression. On the one hand, there are the decades after the end of World War II in the USA, when the relative extent of national debt in relation to economic output was successively reduced via a combination of increased but not dramatically increased inflation, capped interest rates and high growth. This phase is also likely to be the one that gives it the term.
Another period that came close to financial repression was the period after the Lehman disaster and the bursting of the housing/subprime bubble in the US, accentuated in Europe by the sovereign debt crisis, especially in the European periphery. However, compared to the financial repression after the 2nd World War in the USA, inflation did not jump. Especially in Europe, disinflationary tendencies after the Lehman bankruptcy “compensated” for the effectiveness of financial repression. Scientists and politicians, including the aforementioned Kenneth Rogoff, argued that cash had to be abolished in order to enable central banks to impose significantly negative short-term interest rates and thus financial repression.
Not every phase in which nominal interest rates are below inflation can be declared financial repression. For this to happen, there must also be actions by state institutions. But what all phases of financial repression have in common is that the central bank has to play along in order to be really successful.
This brings us to the key of the topic. The current US administration is failing to achieve the promised budget consolidation. However, this government is likely to think about the issue of financial repression without question, as the raising of the so-called third FED target of moderate long-term interest rates shows. In the past, this third goal had been seen as the result of the first two. I think Stephen Miran, adviser to President Trump, but currently temporarily on the Fed Board, sees it more as very independent and as a means to an end (of reducing interest costs). If the Supreme Court rejects the tariffs as illegal in part or in full, then of course the administration will try to reintroduce them with new justifications. But the topic of financial repression may then gain even more momentum.
If it doesn’t work without the central bank, it must also play along. In the USA, Jerome Powell is unlikely to do so. This may also be an additional explanation for the attacks being made on him, and it underlines the importance of President Trump’s decision on the new Fed Chair for May 2026 (likely to be announced around the turn of the year). It cannot be ruled out that an advocate of de facto financial repression will actually be hoisted to the post, this will be one of the key decisions of 2026. In my view, an aggressive form of financial repression is in any case a possible variant, not my base case, which one has to deal with during Donald Trump’s term in office.
What does this mean for the markets?
With regard to the geopolitical crises of this world, I have often explained that capital markets are not a moral authority, but a mechanism that serves to determine the price of various assets. Financial repression is undoubtedly questionable in terms of economic policy and morality, because it negatively affects the savings of the “little man”.
But financial repression does not have to be negative for all asset classes, especially in the short and medium term (and, I quote Keynes, “in the long run we are all dead”). There are asset classes that can benefit from this, especially in the initial phase of financial repression, and, should financial repression originate from the USA, there will certainly also be increased regional effects.
Let’s first come to the obvious losers of such a policy, and it can be said quite flatly that the production of artificially too low real interest rates denies the classic, security-minded government bond investor higher returns. But here, too, since there is no fixed script of how financial repression would work, it becomes clear that the devil is in the details. You have to look carefully at what is done and what is not. Are purchases focused on the entire yield curve or just the short end? Will yield curve control be established and does it refer to several or a few support points? Yield curve control can also take away the risks of an interest rate rise for the period of financial repression, which is not much, but from a risk point of view it is still something. Without yield curve control, there will certainly be a risk that a policy of financial repression will lead to an even steeper yield curve in the bond market.
Let’s move on to possible winners: Higher inflation devalues money, financial repression that only allows moderately higher inflation is not dangerous for economic growth and can certainly stimulate prices for the valuation of real assets such as real estate or shares. Financial repression can thus certainly increase the attractiveness of risk securities at the expense of those of safe investments. Real assets such as shares, private equity, infrastructure, real estate therefore initially benefit, but are also dependent on further government measures, because the state only engages in financial repression when it is looking for revenue.
In the current US administration, other components are added. The thought processes of a part of the new economic team had already been ideologically underpinned in advance: MAGA on the one hand, but also the idea that the USA was being exploited by the trading partners and that “pay-back time” would therefore be due. And much of what has floated from these ideas but has not yet been implemented sounds to me like a financial repression extension, with a component that is only aimed at non-US investors. Some ideas were teased (for example, Section 899, levies on profits of funds in the USA, thought games about voluntary maturity extensions), others are actually forced, such as investments in the USA, which may not be promised for reasons of efficiency, but for fear of sanctions (examples: pharmaceutical industry, chip industry).
In the background, so to speak, the idea of a Mar-a-Lago accord wafts, which had discussed the ultimate financial repression for investors in the USA: a massive devaluation of the dollar. In domestic currency for US citizens a non-event, for US companies a profit injection, for companies outside the USA in their domestic currency the opposite, for the rest of the world an effective reduction in assets. In the treatises on the Mar-a-Lago accord, the dollar weakness was only considered later in Trump’s term in office, but it does not seem to me to be the main topic at the moment. But if you think about the possibilities of realizing such a scenario, then it is definitely part of the construction kit. In fact, for me, forecasting the dollar exchange rate is a key component of any scenario for the coming year.
Europe’s ability to take countermeasures in such a scenario would be limited. The institutional limitations of the eurozone would apply: There is not just one government and one yield curve. Yield curve control in the eurozone would then have to concentrate on many large bond markets at the same time.
This makes it imperative for investors to focus on the topic of financial repression based on the USA as a risk scenario. There would, ceteris paribus, be more of an impulse towards real assets, there would be a particular impulse towards liquid real assets in the US, the picture for real assets in Europe would be mixed, but it would have a more positive effect on European bonds. Financial repression would therefore be a scenario that would bring country allocation to the fore.
