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What is Helicopter Money, WIll It Work and What Are The Risks? PDF Print E-mail
Written by Burnham Banks   
Wednesday, 27 July 2016 01:56

What is Helicopter Money?

There is still much confusion over what exactly ‘helicopter money’ means. In 1969, Milton Friedman coined the term in an extreme example to illustrate a point.

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated." (Milton Friedman, “The Optimum Quantity of Money,” 1969)

In practical terms, helicopter money would require the central bank or some other branch of government to with the authority to create money, to fund the national debt precisely through the creation of money; debt monetization. As such a more precise name for ‘helicopter money’ is Monetized Fiscal Policy (MFP).

What is the difference between QE and MFP?

In QE, the central bank buys government bonds from private investors who had bought the bonds, ultimately from the government. In MFP, the central bank buys bonds from the government. The difference seems almost academic.

So far, QE has been undertaken in the US, UK and Eurozone without deliberately targeting a budget deficit. To the contrary, countries undertaking QE have tended to at least attempt fiscal responsibility. From a prudential management viewpoint this is sound policy but from an economic growth viewpoint this is somewhat self-defeating. When the problem is not undersupply of credit but deficient demand, monetary policy drives interest rates down with low impact on growth. This has been supported by data.

MFP involves operating a fiscal deficit, either in the form of tax cuts or investment spending which is subsequently funded by the central bank. The stimulus effect comes not from lowering interest rates and providing credit or liquidity, but in directly augmenting demand. Output rises directly as a result of the fiscal expansion. Whether or not the capital infusion circulates or gets saved is a separate matter. If the economy is facing deficient private demand it may take some time for inflationary effects to spur private demand.

What are the risks of MFP?

A distinction is often made between debt financed and money financed fiscal policy. This distinction is a very fine one and is not well defined. Proponents of MFP prefer to think of the debt purchased by the central bank as permanent, or written off. The central bank not only buys the bonds of the government but that debt is either perpetual or the central bank promises to maintain its balance sheet through refinancing these bonds in perpetuity. The accounting pedant would consider this debt outstanding and not written off, but that it had a perpetual buyer of last resort. In effect the central bank becomes the lender of last resort to the state, as much as a lender of last resort to the commercial banks. There are risks associated with this role.

We have seen how difficult it has been to wean an economy off QE. The Fed is the least accommodating of the major central banks yet its balance sheet has not shrunk since 2014 despite an end to its asset purchase program. The Fed continues to maintain a 4.5 trillion USD balance sheet by reinvesting coupons and maturing principal.

We have seen also how difficult it is to wean economies off low interest rates. The Fed had planned on a gentle path of rate hikes as early as mid 2015. It has managed one rate hike Dec 2015. The next one may come before Godot. Targeting unusually low interest rates distorts the single most important price in the economy, the price of money, leading to misallocation of resources, and encouraging overcapacity which may ultimately be disinflationary while impairing the profitability and solvency of the banking and insurance industry.

There is a tangible risk that MFP once implemented is accelerated. The experiences of QE and ZIRP have shown the economy’s propensity for chronic dependence on analgesics. Since the central bank acts as lender of last resort to the state, accelerations of MPF can damage confidence and lead to a run on the assets and currency of the country.

How should the money be spent? This is a difficult question in the best of times. Most developed world economies could do with infrastructure upgrades. Better funding of medical and social insurance programs would be welcome. However, public spending is to a great extent a political matter, less so an economic one. The risk that spending is inefficient and does not make a sufficient return on investment, not to the state alone but to society, is high. Also, fiscal spending tends to be sticky upwards, meaning that it is later difficult to cut back when MFP is no longer required. In fact it would increase the probability that MFP once begun would be perpetual.

Tax cuts are another channel for MPF. Here too, the consideration will likely be more political than economic. Given the explicitly unnatural nature of permanently financing a tax rebate by monetization, the design of MFP specific tax structure will likely be highly politicized and contentious.

Unanswered questions following MFP

Since the central bank is the lender of last resort to the state it is reasonable to ask what is the capital position of the central bank, how liquid and solvent is the central bank.

What is the balance sheet of the country? What are its assets and liabilities? Is it well defined?

What happens if the central bank’s accounts were consolidated into the country’s balance sheet?

Last Updated on Wednesday, 27 July 2016 01:59
ECB LTRO. QE Lite But More Effective. Is European Demand For Credit Bottoming? PDF Print E-mail
Written by Burnham Banks   
Wednesday, 20 July 2016 00:28

In December 2011 the ECB embarked on its first 3 year LTRO, or long term refinancing operations. This is basically a secured credit line available to banks posting eligible collateral. LTRO 1 was a great success raising 489 billion EUR which the banks used to purchase sovereign bonds and unwind inter Euro area current account imbalances. LTRO 2 was 529 billion EUR. These initial LTROs were unconditional except for collateral quality. The proceeds were used in the end to buy zero risk weighted assets, sovereigns, and helped Euro area governments to refinance at a time when the bonds markets threatened to close to them. At the same time it allowed banks to borrow cheaply and buy higher yielding assets that consumed little to no capital.

The later TLTROs carried conditions, namely that the banks would be limited to borrowing up to a proportion of their loans to the private sector. The purpose of these conditions was to spur private sector lending. Take up of TLTROs has been slow because for one, the capital consumption of private sector loans is high and so the cost of lending is less impacted by the cheap financing afforded by the TLTROs, and two, private sector demand for credit has been weak.

When the ECB announced QE in early 2016, it also initiated TLTRO II, similar to TLTRO I but with cheaper financing rates, again subject to conditions. Now take up has been very strong, 399 billion at the first auction on June 24. If the high take up is a sign that bank lending is about to accelerate and that demand for credit is rebounding, this would be good news for the Eurozone economy. There are reasons for caution. The TLTRO II auction was opened June 23, the day of the UK EU Referendum. It is very possible that the large take up of LTRO II.1 was simply a risk management reaction to a highly uncertain situation and banks wanted to raise as much liquidity they could.

We are seeing an easing of lending standards and some pick-up in demand for credit from households and businesses but it remains to be seen if this can be sustained. We are a long way from a general releveraging of the economy, which might tilt the balance in favour of equity from debt.

If... PDF Print E-mail
Written by Burnham Banks   
Thursday, 14 July 2016 06:11

If I told you that it was a good idea to buy a negative yielding bond because I thought the yield would get more negative, thus paying for the potential of a future capital gain, you would probably think I was mad. Or seriously dependent on a greater fool. Or bought an option.

If I told you that I would borrow in the bond market to fund dividends which I could not afford to pay out of cash flow or profits, you would probably think me a fool or a fraud.

If I told you I would borrow in the bond market to buy back my shares because funding was cheap and I didn't know what else to do you might reasonably question my leadership qualities.

If I told you I would borrow to buy out my competitors you might question my judgment, and if you were the regulator you would certainly question the systemic competitive implications.

If I told you that stocks were cheap relative to sovereign bonds and interest rates despite slowing earnings growth and high absolute valuations you might ask how closely I monitored the bond market.

If I told you I would cut rates even into negative territory to spur lending you might reasonably ask me who wanted to borrow.

If I told you I was making banks safer by asking them to hold more capital, and apply better risk models, you might ask me how I expected them to lend.

If I told you I was going to apply more fiscal stimulus to revive our slowing economy you might ask me how I was going to pay for it.

If I told you I would buy more sovereign bonds, you might ask me where I was getting the money. Well, why do you suppose I might need to issue more sovereign bonds?



Last Updated on Thursday, 14 July 2016 06:22
Final Act For Falling Bond Yields and Interest Rates? QE + Fiscal Policy. Helicopter Moiney. PDF Print E-mail
Written by Burnham Banks   
Monday, 18 July 2016 01:58

We have seen how effective QE can be. Not very. Not for Main Street at least. For Wall Street, QE has depressed bond yields and helped to camouflage the overvaluation of paper assets supporting them at inefficient levels for too long. More than that, the effectiveness of QE is wearing out like an over prescribed antibiotic. Now the global economy is still growing, not fast, but still growing. The US economy is in rude health. But the progression of inequality coupled with paltry growth means that the mass of the population is actually experiencing falling standards of living, even as aggregate data show improvement.

Lately, the talk of helicopter money has been gaining volume. The practical deployment of helicopter money is fiscal deficit spending funded not by tax but by debt monetization, in other words, QE. So far QE has been less effective probably because it was an attempt to clap with one hand. At last, this failure may be addressed. This may solve some issues and get the economy growing faster, hopefully to compensate for the rising inequality so that the masses may be raised out of their financial stagnation. However, there are a few minor side effects. The national debt will gro. Fiscal policy funded by tax is neutral and ineffective. Deficits will have to be increased. QE will have to continue. Just because it had limited impact in the absence of fiscal policy doesn’t mean we can stop now. Private investors have been happy to join their central banks in funding their governments, but only because there was some semblance of fiscal responsibility. Abandoning fiscal responsibility might result in an investor revolt meaning a backstop financier has to be found. Enter, again, the central banks. Bond yields may rise. Loose money sinks interest rates but loose budgets raises them. The loss of private investment demand will likely put a floor under interest rates. Central banks will have to be careful to not allow financing costs to rise too quickly increasing debt service for the government and for corporates. Bond yields are likely to stop falling, how quickly they will rise depends on the determination for further QE and the risk of investor revolt. Given how indebted countries are to begin with, central banks will likely be very careful to cap debt service for their masters.

Helicopters are usually the sign of a last ditch attempt. Hopefully this is not the case here.

Last Updated on Monday, 18 July 2016 02:00
How To Encourage Electric Vehicle Proliferation PDF Print E-mail
Written by Burnham Banks   
Thursday, 14 July 2016 05:35

Electric vehicles need a little help. It’s no use each manufacturer pursuing their own thing. For EVs to really take off what is needed is agreement on standards.

  1. Batteries should be standardized or at least modularized.

  2. Charging takes too long. Battery swapping is better than car charging.

  3. Batteries should be modular so that more power can be added simply by adding more batteries.

  4. Replace petrol stations and charging points with battery points. Battery dispensers provide battery exchanges so depleted batteries can be swapped for fully charged batteries for a fee.

  5. Battery dispensers take up little space and can be ubiquitous and distributed.

  6. Returned depleted batteries are charged and recirculated.

  7. Cars can choose if they wish to run with one battery or two or several depending on their needs. Cars can be designed with varying maximum battery capacities.

Last Updated on Thursday, 14 July 2016 05:42
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