A mechanism by which governments buy foreign bonds in an effort to sterilize currency is referred to as Financial Repression. There is a direct proportionality between the degree to which this process occurs and the liberality of said political economy.
To hold down interest rates as an offset to the value of currency are the effects of financial repression. This, in turn, due to the relative value of [cheap] money leads to a more competitive trade regime in said country.
Hume’s Price specie flow mechanism would otherwise cause the money to appreciate as trade balances of said countries became increasingly positive. However, the financial repression maneuver works to artificially stop the rising tide of natural price fluctuations in the international money market in such a way that a disequilibrium takes place between a government’s cost of capital and it’s returns on foreign exchange reserves.
The pressure that is buildup as a result of this differential that is also reflected in interest rates will cause the financially repressive economy to experience decreasing marginal returns on its foreign assets. Consequently, continuing this process of holding foreign monies in order to reduce the price of one’s currency is an unsustainable one.
financial repression shows its results in the form of inflation in such a way that the underlying value of currency is distorted. Hence, the price of risk on instruments that are linked with the said currency is distorted. This urge the investors to under compensate for return on investment(ROI) and they will overextend themselves for finding greater profits as economic profits are inevitably shrink to zero by perfectly competitive markets. When the investors start searching for greater profits than this thing leads them to excessive risk taking (on thin margins) and then it will invariably lead to some sort of implosion for e.g.,LTCM in 1998 or the 2007 subprime mortgage financial crisis
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