The economic development over the past few weeks bearing the greatest potential unintended consequences was not Brexit or the unfolding Italian banking crisis, but rather the secret meetings between former Fed Chairman Ben Bernanke, Japanese Prime Minister Shinzo Abe, and Bank of Japan Governor Haruhiko Kuroda. While held in private, it has been widely speculated that the meetings were a pitch for Japan to adopt helicopter money, as evidenced by the 9% rally in the Nikkei 225 last week and the Yen’s biggest weekly drop in the 21st century. Speculation was further fueled by the announcement of a ¥10 trillion stimulus package later this year along with further monetary policy easing.
For readers not familiar with the concept, helicopter money (or less colloquially Money Financed Fiscal Programs) is the last resort in the monetary policy playbook whereby the central bank monetises government fiscal expenditure by either directly crediting a government Treasury account with funds or converting government bonds into zero-coupon perpetual bonds. This differs from QE, as under QE the government issues coupon-bearing bonds with fixed maturities (rightly classified as debt), while helicopter money is an interest-free, permanent increase in the money base. The gravity of this distinction cannot be overstated – helicopter money allows the government to engage in fiscal stimulus of any amount deemed necessary without issuing additional debt or increasing tax revenues. It is, in effect, the ultimate form of fiscal and monetary policy unification.
It should not come as a surprise to regular readers of financial news that Abenomics and QE are faltering in Japan. Since implementing negative interest rate policy (NIRP) in January 2016, the following milestones have been reached:
- Almost 90% of Japanese Government Bonds (JGB) carry negative yields;
- The BoJ now owns almost 30% of all outstanding JGBs, purchasing at a pace set to reach 50% by 2017 in an increasingly illiquid market;
- The BoJ also owns 55% of Japan’s ETFs and is a top 10 shareholder in 90% of the Nikkei 225; and
- Kuroda’s 2% inflation target is nowhere in sight.
The record low yields have not only made JGBs one of the best performing investments globally (up more than 8% YTD), but also created further deflationary signals.
It is against this backdrop that speculation of helicopter money in Japan arose. Leaving aside the legal obstacles to implementing helicopter money in Japan (or any other country), and Kuroda’s denial that such a policy would be used (the same Kuroda who denied NIRP a week before it was implemented by the BoJ), it is prudent for investors to consider what incremental impacts, if any, a helicopter drop may have on the economy and on their portfolios.
Arguments for helicopter money
- Governments can fund infrastructure investment programs or tax cuts at zero cost, both of which should theoretically increase aggregate demand and create inflation since there is no anticipated future increase in debt servicing and tax burden. Unlike traditional QE which pushes down bond yields to encourage consumers to borrow and spend, central bank-monetised tax cuts are directly “QE for the people”.
- Helicopter money, which is directed at infrastructure projects and tax cuts instead of large-scale asset purchases, could potentially be less risky than QE, which has been blamed for fueling what some investors see as historic bubbles in the global stock and bond markets while not translating into inflation.
- In an economy like China with an insolvent banking system and insolvent SOEs, the central government (through the PBOC) is the only state entity with sufficiently deep pockets to fund and navigate a transition away from heavy-lifting infrastructure investment towards a consumption economy with investment in social / affordable housing and urbanisation infrastructure.
Arguments against helicopter money
- A number of economists argue that QE is already thinly disguised helicopter money. With government bond yields at record lows across developed markets, government borrowing costs across various maturities are already approaching zero. Since central banks are owning an increasing percentage of government bonds outstanding, an increasing percentage of debt service costs are being remitted back to the government. Take the US for example: in 2015, the US government paid $223bn in interest payments, of which $98bn was received by the Fed and remitted back to the US Treasury. Governments also rarely, if ever, redeem their debt (instead simply rolling the maturity with newly issued debt), so the debt can be considered perpetual. Therefore, there is no incremental benefit to the money base, but there is added risk of runaway inflation (see points below).
- Given the global malinvestment that was precipitated by years of record low interest rates, and declining productivity in Developed Markets, an increase in the money base without a corresponding increase in real output puts inflationary pressure on prices. If inflation increases faster than expected, central banks may have limited policy tools to control it without adversely affecting asset prices, and indeed many central banks are still trying to get more negative. Furthermore, any attempt to contain inflation by shrinking the money base will end up reversing the benefit of helicopter money in the first instance (fiscal stimulus funded by permanent increase in money base).
- A not unfounded concern of using helicopter money to facilitate a one-off increase in the money base is that it may not be one-off, and thus lead to high inflation or even hyperinflation.
- Kuroda’s denial of helicopter money in Japan stems from historical experience. In the 1930s, Japanese Finance Minister Korekiyo Takahashi used money financed fiscal stimulus to drag Japan out of the Great Depression. When it came time to rein in spending, strong opposition to austerity resulted in Takahashi’s assassination and Japan experienced rampant double-digit inflation in the late 1930s.
- Similarly, the Weimar Republic experienced a period of hyperinflation in the early 1920s as a result of mass printing of paper Reich marks to buy foreign currencies required to pay Germany’s war debt and reparations imposed by the Allies, without having the economic resources to back up the value of the mark. This form of helicopter money drove inflation to 29,500% per month at its peak, and the ensuing economic misery ultimately led to the rise of National Socialism and Adolf Hitler. It is for this reason that the current German political establishment vehemently opposes helicopter money and why the ECB will face staunch opposition against such a policy.
- The US QE episode has shown that asset prices respond to the “flow” of central bank money (expansion of Fed balance sheet) rather than the “stock” of central bank money (size of Fed balance sheet). If a one-off “flow” of helicopter money does not stoke inflation, one should not put it past the Keynesian economists at the central banks to order more of the same medicine.
In summary, helicopter money carries with it an appreciable risk of high inflation that may prove difficult for central banks to control without adversely affecting asset prices. While Kuroda, Draghi, Yellen and the PBOC have not overtly motioned to “get to da chopper” yet, we at Montaka will be monitoring the situation closely, particularly as it relates to rising inflation expectations and the impact on stock prices.