What will a blizzard of free cash mean for your wealth?
Central banks and policymakers are thinking the unthinkable – but will they do it too? And what will the consequences be? Rupert Foster reports.
When George Washington stood for the Virginia House of Burgesses in 1758 in a seat with an electorate of 370 voters, he gave away, on election day, 28 gallons of rum, 50 gallons of rum punch, 34 gallons of wine and 46 gallons of beer nearly half a gallon per voter. Even then, he feared his campaign manager had "spent with too sparing a hand".
In the years to come, we may look forward to another George Osborne showering us with pre-election goodies in a bid to tempt us to vote for him. But Osborne might not have to worry about being sparing because by then, he may well be able to draw directly on the central bank to print the money to pay for those goodies, using what economists call "helicopter money".
The term "helicopter money" describes a policy where the government no longer funds its overspending by issuing bonds, but instead has the central bank print extra money that it then spends, or literally hands out to the population, through tax rebates or grants. The name comes from Milton Friedman, the father of monetarist economics, who jokily imagined helicopters flying over America, with the occupants throwing $1,000 bills out of the back to the grateful masses. While the reality would look somewhat different, the desired effect should be similar.
The policy sounds bizarre, but it is backed by an increasing number of influential figures, including Ray Dalio (founder of Bridgewater, the world's largest hedge fund), Willem Buiter (chief economist at Citigroup) and our own Adair Turner (the former head of the Financial Services Authority). So why now? How would it work? And what impact will it have on investors?
Warm up the choppers
The idea of helicopter money seems to fly in the face of all prudent financial practice. Politicians have always been told that it was taboo to print money and dole it out, or to use it for their own spending (on the basis that hyperinflation will inevitably ensue). And for good reason. The danger is that if they are allowed to do it without obvious and immediate negative consequences, they will never stop. So why is everyone talking about doing it now? And why have quantitative easing (QE), or the more recent negative interest-rate policy (NIRP) from the European Central Bank and the Bank of Japan not had the desired effect?
In answering these questions, politicians, regulators and central banks will be forced to challenge the accepted wisdom of macroeconomic policy since 2008 indeed, since the US and UK financial deregulations of the early 1980s. Traditional central banking has focused on that 1970s evil inflation which has been fought by manipulating interest rates.
As the economy heated up and inflationary pressure started to emerge, the central bank would raise its interest rate, which led banks to raise their own rates and thus discouraged further borrowing by corporations and individuals (the "credit transmission mechanism"). Inflation slowed as the economy slowed. And if the economy slowed too much and unemployment started to rise, the central bank cut rates, banks offered cheaper loans, and borrowing increased, allowing for the creation of new demand and jobs.
During the financial crisis of 2008/2009, developed economies shrunk drastically. The natural reaction of central banks was to cut rates as quickly as possible, in an effort to provide cheap financing to banks so that they could rebuild their balance sheets and start lending again. But US and UK central bankers knew that the financial crisis was different from a normal recession the speed and size of the economic slump and the weight of the accumulated debt in the system meant there would be a threat of deflation. So QE was put in place to support asset prices (and thus fight deflation) and also to provide more money to the banking system so that the credit transmission mechanism would restart.
However, that mechanism has largely broken down since 2008. The US has led the developed world in loan growth since 2008, but it has averaged just 2% a year since 2009, its lowest in 80 years. The eurozone has trailed even these paltry levels. And the numbers appear larger than they are. Central bankers wanted to boost bank lending to the real economy: ie, to allow for increased purchases of widget-making machines for our great widget makers.
But since 2008 almost all loan growth has gone to firms indulging in mergers and acquisitions or share buybacks, or into the acquisition of already developed real estate. The value of share buybacks has recently hit an all-time high, and the London property market continues its eye-watering climb.
This looks a lot like Japan
What's worrying is that we are continuing to follow the Japanese playbook in other words, it was entirely predictable that we would end up here. In the end, the banking sector, corporations and individuals are, unsurprisingly, acting in their own self-interest and not for the greater good. And the trouble is that economic optimism is in short supply. Everyone can see that while QE may force up asset prices, the real economy is not actively recovering and we may be heading for another recession very soon. So banks don't want to lend, companies don't want to invest, and private individuals do not want to spend as they used to.
This is made even worse by central banks imposing negative interest-rate policies. These are doomed to fail, as they actually damage the sensible banks further (by hurting their profit margins) and send an incredibly negative message to consumers, by suggesting that central banks are very worried about the outlook. That's a problem, because creating renewed optimism is at the core of the policy. ECB boss Mario Draghi's bribe to European banks to lend last week looks clever and large (at 17% of eurozone GDP), but the banks will not use the facility, as they do not want to lend to more risky borrowers not even for a 0.4% uptick in their net interest margin (see the column below for more).
Something must be done
So current central-bank policies will continue to fail to make a difference which will increase the clamour for the authorities to "do something". Global GDP growth will continue to slow this year as China's economy (the main driver of global growth) will not reaccelerate (even with continued massive credit creation a world-beating $500bn in January this year alone) as it makes its slow shift from being an investment-led economy to a consumer-led one.The US remains the strongest developed economy, but the impact of the Federal Reserve's lack of money printing and the strength of the dollar will start to drag on growth. The eurozone is split along the traditional north/south divide. Germany is fine, but southern Europe is still holed below the waterline. It's impossible to argue that we are heading in the right direction when Italy, the eurozone's third-largest economy, has a banking sector with non-performing loans (bad debt) running at near 20% and youth unemployment near 40%.
"Optimism is in short supply: everyone can see that while QE may force up asset prices, the real economy is not actively recovering and we may be heading for another recession very soon"
The International Monetary Fund and others are now trying to build a consensus for a concerted dose of fiscal stimulus (government spending), particularly in those countries running noticeable current-account surpluses. Japan will undoubtedly encourage this at the G7 meeting in May, which it is hosting. George Osborne will, judging by past experience, find it easy to ditch his austerity policies, particularly as he builds up to his own leadership bid.
However, that said, debt-funded fiscal stimulus (borrowing big to spend on infrastructure) is still likely to be constrained. As a result, populists will start to discuss stimulus aimed at the "average man" Jeremy Corbyn's "People's QE" is one such example. Japan is the most likely to adopt helicopter money first, as Japan has been in a deflationary environment the longest.
One proposed policy doing the rounds in Tokyo is a gift of $100,000 to the parents of every new child born an adept way of killing two birds with one stone, given Japan's shrinking population! Europe is most likely to be second, with Germany's vociferous hostility to these sorts of policies being worn down by its desire to keep the eurozone together by stimulating growth in southern European states.
A gift for populism
Outside Japan, where monetary policy experiments are increasingly well established, what will it take for helicopter money to become politically acceptable? For a clue as to the environment we need, you only have to look to the increasing popularity of the likes of Corbyn, Donald Trump in the US, and Marine Le Pen in France. A populist politician will have to find someone to blame, someone who has created the need for this dramatic policy shift. And this is where the banks' self-centredness and general lack of penitence will finally come back to haunt them.
Banks will be the whipping boys as politicians try to convince their populations that they should be given control of money printing. And what populist would not welcome that control Trump?Le Pen? They can easily argue that existing forms of stimulus, from QE to negative rates, have done nothing but make the rich richer now it's time for the "have-nots" to get their turn.
Over the next 18 months, all of the leading Western political leaders will run a gauntlet of elections, or referendums. Will these be the last elections fought without the voter accelerant of half a gallon of good liquor? It appears increasingly likely.
How to invest before the helicopters take off
The impact on markets will depend on the amount, and style, of helicopter money adopted. Prior to any full-scale adoption there will be much talk of hyperinflation and the abuse of power by politicians. This could affect currencies and bond markets noticeably (with both falling, you'd expect). It will also depend on which politicians are in charge if Trump or Le Pen are in charge of such policies, they may well be viewed with far more suspicion than Angela Merkel or Hillary Clinton, for example.
Is hyperinflation the inevitable result? Adair Turner, author and former financial regulator, argues that to conduct helicopter money, specific government bodies will be needed to discuss the policy, and to come up with a framework for both the method and the amount. That might sound sensible. But Turner also argues that, in the end, it will come down to trial and error. You start low. If there is no spike in inflation, you add a bit more, and if there is a big spike in inflation, you back off. Hardly reassuring.
That said, the process is likely to start "small" with highly targeted grants or government spending such as the Japanese baby grant mentioned above. Or perhaps, as Russell Napier suggests, student debt might be written off, using central-bank-printed funds. Indeed, the simple cancellation of bonds held under existing QE schemes would also count as helicopter money (the only reason QE isn't already outright deficit financing is because the central banks holding them claim to have the intention of releasing them back in to the market one day).
"Since 2008almost all loangrowth hasgone to firmsindulging inmergers andacquisitionsor sharebuybacks"
The only reason these policies are even being considered is because deflationary pressure is so great. By the time helicopter money is enacted (probably following a recession that will further entrench deflation), people will feel that a spike in inflation is the least of our worries not unlike the Weimar Republic's citizens at the beginning of Weimar's crippling hyperinflation.
The other policy that could be used is loan quotas ie, banks being forced to lend to certain sectors at certain levels. This strategy was followed successfully in Japan after World War II many people believe it was the core of Japan's economic success. The Chinese actually use a watered-down version of it now. Generally, all helicopter-money policiesshould be inflationary, and so should be good for commodity prices (particularly gold, which should benefit from the inevitable concerns about financial stability too) and other stocks that benefit from inflation. And targeted helicopter money will be great for stocks exposed to the areas in question. Focused government spending may well also include specific infrastructure projects such as Crossrail 2 or super-high-speed broadband, or a graphene production company, say.
However, I think helicopter money will be bad news for banks. Once the government has the ability and the political mandate to create its own money, then the banking sector's special place in the economy is eroded. As a result, the banks' special treatment will also be difficult to justify. This will mean that deposit insurance will be removed as this works as a massive equity stopgap to the banking sector. This will encourage banks to shrink themselves and it will also encourage depositors to move their money to healthy banks. Banks may also be forced to take on more equity. This will be negative for banks and will make them a rather boring utility investment in the long run.
Rupert Foster has been a pan-Asian equities fund manager for the last 20 years.
Mario Draghi fires up the presses again
In December, European Central Bank Governor Mario Draghi rather disappointed markets when he decided against launching any more big stimulus packages. Ever since, he'd been dropping hints about making bolder moves at last Thursday's ECB meeting and he wasn't joking. He cut the ECB deposit rate further, from -0.3% to -0.4%. This means that banks have to pay slightly more on the reserves they hold with the ECB, which is intended to encourage them to lend the money to consumers and firms. He also cut the ECB's refinancing rate and borrowing rates to 0% and 0.25% respectively.
This was all broadly expected. But he then managed to surprise markets by significantly boosting his quantitativeeasing plans. Firstly, the ECB raised the amount of monthly QE it is doing from €60bn to €80bn an overall increase of €240bn in QE still to come. He also broadened the range of assets that will be eligible to include the bonds of investment-grade non-financial companies, and those of development banks and international organisations. Finally, Draghi launched another round of targeted longer-term refinancing operations (TLTRO). In short, this allows banks to borrow money from the ECB at rates as low as -0.4% (ie, they are effectively paid to borrow), as long as they lend it into the "real" economy.
The euro initially slumped to around $1.08. However, during the press conference that followed, while Draghipromised to keep rates low for the duration of the programme (due to finish in March 2017), he stated that further rate cuts were unlikely, which sent the single currency leaping back to $1.12.
But, as Jonathan Loynes of Capital Economics points out, he may not be done here: in response to a question on the topic, rather than dismiss it out of hand, Draghi said that helicopter money was "a very interesting concept but we haven't really studied [it] yet". As Loynes puts it, "the fact that such a policy is even being discussed in a modern developed economy is testament not only to the seriousness of the eurozone's deep-seated problems, but also to the continued overreliance on the central bank to address those problems".