Policymakers ponder "helicopter money"

by Michael Collins, Investment Commentator at Fidelity International

June 2016

In Japan, negative interest rates on bank deposits held at the Bank of Japan are blamed for rising bad debts on bank books and slower lending growth. In Denmark, where interest rates have been negative the longest, businesses and consumers are saving more than they did before 2012. The radical step on rates taken four years ago has dented the confidence to spend and invest. Across the eurozone, (as in Japan), bank shares have tumbled because the negative deposit rates imposed by the European Central Bank are eroding the profit margin between borrowing and lending rates enough to raise concerns about the strength of banking systems.[1] Others worry that negative interest rates are distorting prices on financial markets, risking fresh bubbles.

The menace a sub-zero price on money poses to the fiat (unbacked) monetary system and fractional-reserve banking clashes with the goal of central banks to ensure financial stability.

The inability of negative rates to revive deflation-ridden economies is undermining confidence that central banks can guide economies to health. At the same time, quantitative easing is losing its potency, while pumping up central bank balance sheets to unheralded proportions and turning sovereign yields negative.

Something must give. Options touted to encourage the spending needed to heal economies include taxes on cash and bank deposits and compulsory wage increases for the private sector. Amid the angst and pondering, one option is emerging as the likely fallback. Talk is rising that policymakers will soon resort to so-called “helicopter money”. Helicopter money, for all its modern-sounding name, is an old-age answer to stoking nominal demand and inflation. It’s traditional money printing, a phrase that has been hijacked to (mis)describe quantitative easing. Whatever it’s called, creating money out of nothing then handing it to the public in the hope they spend, spend, spend would be a watershed event. It risks resurrecting excessive inflation. Less obvious, perhaps, helicopter money would challenge, even end, the concept of “independent” central banking.

Helicopter money may be too revolutionary for a world conditioned to think that inflation is bad. The policy could backfire if squeals about Weimar Republic-style hyperinflation crippled confidence. The solution could prove problematic because, once started, policymakers may find helicopter money too tempting to switch off. Many countries (but not Australia) have laws that appear to bar the practice. But as long as economies struggle and deflation poses a risk, support for money printing will grow. If policymakers don’t turn to helicopter money to thwart any looming downturn, they might be forced to implement the option anyway if a crisis were to eventuate.

Chopper cash

A helicopter was first flown in the US in 1939 when Igor Sikorsky gained height in a machine that had a single main rotor and a tail rotor.[2] It’s thus an incongruous term to describe money printing because policymakers have resorted to this option ever since coins were first minted and notes were first printed centuries ago – in 600 BC and the 6th century respectively, according to many reports. When money was in the form of coins, creating money from nothing took the form of reducing the amount of pure metal in (usually silver) coins. This could be done by reducing the size of the coin or by adding impurities to the metal. Sometimes this debasement was done because the value of the metal exceeded the face value of a coin. More often than not, it allowed rulers to spend money they didn’t have without increasing taxes, a surefire remedy for inflation. Under the gold standard, where the value of money was based on a fixed amount of gold, money printing was running off banknotes that weren’t backed by gold. It was typically an option taken by bankrupt rulers with, say, disgruntled soldiers or bond holders to pay, and proved inflationary.

Printing fiat money usually takes the form of the Treasury ordering a central bank to increase the monetary base to plug a fiscal deficit widened by tax cuts, higher spending or a mixture of both. Under modern practice, the central bank would either buy the bonds the government issues to pay for its deficit (rather than these bonds being sold to the public) or it would credit the Treasury’s account at the central bank. Either way, the central bank’s balance sheet would swell. The term helicopter money originates from 1969 when Milton Friedman spoke of dropping banknotes from a helicopter when pondering the optimum quantity of money an economy would need to be in balance.[3] The phrase became infamous as a nickname for Ben Bernanke after “Helicopter Ben” in 2002 suggested authorities in Tokyo fight deflation by forcing the Bank of Japan to finance tax cuts.[4] Given the link between a central bank and the Treasury’s deficit, printing money is often known as monetising a deficit or monetary finance.

Helicopter money, in theory, comes with the advantage that it is likely to power nominal demand without boosting future tax burdens. To convince people to spend the new money in their hands, they must think higher taxes won’t claw back the windfall. The money printing would only end when inflation reached a pre-determined level. The policy, however, could fall flat if people saved the handout. UK Labour leader Jeremy Corbin’s proposed “People’s quantitative easing” is designed to avoid this problem by using money printing to fund investment in infrastructure.

Helicopter money as economic policy, almost needless to say, stokes numerous controversies. The issue that garners the most attention is the risk of uncontrolled inflation, even to the point that it could torpedo confidence in fiat money.

Spot on

In 1945, authorities in Soviet-conquered Hungary began printing the new peng? currency to stimulate an economy damaged by war. Combined with oppressive reparations to the Soviet Union for fighting on the German side and uncertainty created by plans to nationalise the economy, the monetary stimulus triggered what many consider the most extreme hyperinflation ever recorded. At its peak in mid-1946, the Hungarian currency halved in value every day. That’s inflation of 100% a day, which is almost beyond comprehension at an annualised rate. When the florint currency was introduced in August 1946 to normalise payments it was worth 400,000 quadrillion peng?. That’s 29 zeros.[5]

Money printing has unravelled in a similar way in Argentina in recent decades, famously in Germany in the early 1920s, in Venezuela now, in Yugoslavia in 1993-94 (when some claim inflation exceeded Hungary’s of 1946), and in Zimbabwe in the 2000s. As economies collapsed, people survived by issuing alternative money, adopting a foreign currency, bartering and foraging. The upheaval within society is close to revolutionary because creditors, savers, the middle class on wages and the retired on pensions get wiped out.

Today’s policymakers are pondering money printing to combat sluggish growth and low inflation or mild, even innocuous, deflation. They are not challenged by the savage price drops that occurred during depressions after World War I and in the 1930s. They seek only to engender a little inflation. To do that, their challenge would be to create just the right amount of monetary stock. On top of this, they would need to control bank credit creation that feeds off increases in the monetary base. Essentially, for money printing to work, authorities need to convince the public that they can responsibly manage what is regarded as irresponsible policy. It wouldn’t be easy to judge how much extra money would be needed to boost inflation towards healthier levels while retaining public confidence in economic management. In theory, though, it’s possible.

Successful episodes of money printing have occurred, where success is judged by a growing economy and acceptable inflation. The US resorted to money printing to finance the war effort in World War II and inflation only averaged 7% from 1940 to 1948.[6] Back then, though, Washington could rely on price and wage controls to contain inflation and opposition was muted, even censored. In today’s populist political environment, the holler against the policy that has helped keep Robert Mugabe in power since 1981 while destroying Zimbabwe’s economy would be thunderous.

These political constraints appear less of a problem in sluggish and deflation-prone Japan. Given that quantitative easing is failing to pull the country out of its slump and that the Bank of Japan is running out of bonds to buy, Japan could soon opt for helicopter money. It’s no certainty, however, because opposition is lined up against the policy that enabled Japan to be the first country to lift itself out of depression in the 1930s. If Tokyo were to opt for money printing, success in Japan could inspire countries in Europe to do likewise.    

Fading independence

Given that money printing is giving cash to the public, it must occur through fiscal policy, which is under the Treasury’s jurisdiction. Quantitative easing, when a central bank expands its balance sheet to buy securities from its primary banks, occurs within monetary policy. To put it another way, money printing hits the federal government’s budget, whereas quantitative easing doesn’t (outside of the fact that it boosts central-bank profits, an item in the budget).

Many allege that today’s radical monetary policy has blurred the straightforward, even if artificial, demarcation between fiscal and monetary policy. Some consider the amount of bond buying by the Bank of Japan as de facto money printing because the central bank’s purchases exceed the sale of bonds each month and it’s now buying bespoke ETFs of companies that are boosting investment and wages, two actions the government seeks.[7] Germany’s Bundesbank alleges the ECB’s asset buying and other monetary stimulus have “blurred the line” between monetary and fiscal policy.

Some advocates of money printing have central banks overseeing the policy by setting a ceiling on the amount of money printed. Such a stance would mean central bankers were supervising politicians and would be regarded as central bankers usurping their role as public servants. More likely than not, though, money printing would worry the public because it would reassert politicians above central bankers. However it was done, money printing could end the concept of “independent” central banking that began with the Bundesbank in 1957 (even though in a constitutional sense central-bank independence is a mirage outside of Germany).[8] If authorities do opt for money printing, then along with free trade and the unhindered flow of capital, the global financial crisis would have damaged another hallmark of modern-day, liberal-democratic capitalism.

Financial information comes from Bloomberg unless stated otherwise.

[1] The threat to bank profits, thus stability, has triggered a 16.3% decline in the STOXX Europe 50 Bank index compared with 5% drop for the Stoxx Europe 50 Index in the first five months of 2016.  In Japan, the Topix Banks Index tumbled 24.4% in the first five months of this year compared with a drop of 8.6% for the Topix index.

[2] Connecticuthistory.org. http://connecticuthistory.org/worlds-first-helicopter-today-in-history/

[3] Milton Friedman. “The optimum quantity of money.” Aldine Transaction. 1969

[4] Ben Bernanke “Deflation: making sure ‘it’ doesn’t happen here.” 21 November 2002. National Economists Club, Washington DC. https://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm

[5] See Anne Applebaum. “Iron curtain. The crushing of Eastern Europe.” Penguin 2012. Pages 255 and 256.

[6] The Wall Street Journal. “Yes, central banks can create inflation. Just ask Argentina.” 27 April 2016. http://www.wsj.com/articles/yes-central-banks-can-create-inflation-just-ask-argentina-1461767299

[7] Financial Times. “Japan fund managers create customised ETFs for central bank.” 18 May 2016. http://www.ft.com/intl/cms/s/0/8ce142a6-1cb8-11e6-b286-cddde55ca122.html#axzz48mxVZ87R

[8] Deutsche Bundesbank. “The road to central bank independence.” https://www.bundesbank.de/Redaktion/EN/Topics/2013/2013_10_29_bank_independence.html