Posted by on April 30, 2016

If you aren’t familiar with this expression by now, you shortly will be.  In just two recent days, articles on this subject popped up in The Wall Street Journal (here and here) and the Economist (here).  Both the European Central Bank (ECB) and the Bank of Japan (BOJ) have recently publicly mused on the subject, with Mario Draghi, head of the ECB, calling it a “very interesting concept.”  If the world economy continues to be sick, then there is a good chance that this will be promoted as the new experimental treatment.

The origin of “helicopter money” is a speech given by Ben Bernanke back in 2002 entitled “Deflation: Making Sure ‘It’ Doesn’t Happen Here.”  The idea, however, has an earlier origin in the writings of Milton Friedman, who proposed a “helicopter drop” of money as the last resort of a central bank looking to fight deflation.

The idea is simple.  A central bank that has failed to counter deflation with the “usual” tools of monetary policy – interest rates, reserve requirements, and, in our brave new world, quantitative easing, “operation twists,” Long Term Refinancing Operations, etc. – could simply shower the populace with newly created fiat currency.  The bank could mail a check to every citizen or even shove the freshly printed bills out the open door of a helicopter.   Once spent, the new money would add to aggregate demand and increase the price level.  Or at least that is the theory.

What I don’t understand, however, is how anyone thinks that this is any different from what has already been happening?

Let’s take the case of the United States.  From 2009 to 2015, the Federal Government ran cumulative budget deficits of about $6.7 trillion dollars.  This basically represented money borrowed by the Feds and handed out as transfer payments to citizens, payments to contractors on “shovel-ready” infrastructure projects, or loans to Solyndra (which in turn spent the money on salaries, solar panels, lobbyists, political contributions and bankruptcy lawyers).  But it could have just as easily been shoved out the door of a helicopter.

Over the same period, the Federal Reserve’s assets grew by about $3 trillion, with most of the growth in the form of various government securities.  These represent securities bought in the open market by the Federal Reserve, using newly created fiat currency.  These are existing securities, rather than newly issued ones, but since the bonds are fungible, this is a distinction without a difference.  By buying the existing bonds, the Federal Reserve creates replacement demand in the private sector for new issues.

In other words, to the tune of about $3 trillion, the US has already been engaging in helicopter money.  But it has been doing the “helicopter two-step”: the Federal government issues debt to shower money on the populace, while the Federal Reserve has been simultaneously hoovering up bonds with newly created cash.  The end result is money in the pockets of the private sector ultimately funded by the issuance of more fiat currency.

The example is even more exaggerated in the case of Japan.  Japan is borrowing nearly 50% of its current government expenditures and it has been doing this for a long time.  Simultaneously, the BOJ has been buying up over 100% of the net new supply of government debt.  The BOJ now owns over 34% of all the outstanding government debt in Japan, a figure which is projected to grow to 50% by 2017.  All of this represents helicopter money via the two-step.

This is why Olivier Blanchard, the former chief economist of the International Monetary Fund, dismisses helicopter money as nothing more than an expansionary fiscal policy by any other name.  A recent article by Reuven Brenner, holder of the REPAP chair in Economics of McGill University in Canada, points out that this policy is the same as the one followed by the Federal Reserve during World War II, except that in this case it was explicitly recognized to be the handmaiden of fiscal policy.

So, why all the fuss about helicopter money?  Careful readers will note that there is one difference between pure helicopter money and the two-step.  In the case of the latter, the central bank ends up with an asset on its balance sheet, backing up the new issuance of money, which shows up as a liability.  In the case of pure helicopter money, there is nothing on the asset side.  Which means that, since most central banks are thinly capitalized, helicopter money would quickly cause the central bank to become bankrupt from an accounting perspective.

But who cares?  It is one of the abiding economic anachronisms that the accounts of a central bank matter.  Central banks issue currencies but they are not the source of their creditworthiness.  This comes from the “full faith and credit” guarantee of the relevant government, from which the central bank is indistinguishable in the eyes of the public.  Whether the central bank is solvent from an accounting perspective is irrelevant.

For a tangible example, the Swiss National Bank (SNB) just declared a $23.5 billion loss in 2015 as a result of its attempts to suppress the value of the franc.  These failed attempts caused the SNB to incur a huge loss on the foreign currencies it had bought.  I don’t know if this was sufficient to wipe out the capital of the SNB, but I doubt it would matter if it were.  The world will still rush to the Alpine safe haven even if the SNB has a big hole in its balance sheet.

In fact, the absence of an asset is part of the appeal of helicopter money to the ECB and the BOJ.   Both are running into practical difficulties in their efforts to inflate the money supply and manipulate market prices.  The ECB is required to spread its purchases around in accordance with a formula that considers the size of each member state’s economy and its contribution to the ECB’s capital; this means that the ECB may be running out of bonds to buy in certain markets unless it changes the rules.  The BOJ, which has been at this much longer, has been buying anything that isn’t nailed down.  In addition to dominating the market for government bonds, as mentioned above, the BOJ has become a top 10 shareholder in 90% of the companies on the Tokyo Stock Exchange through its purchases of exchange traded funds (ETFs).

Although I don’t think that helicopter money is much of an innovation, don’t get me wrong.  I am not saying that “we have been doing helicopter money all along, so WTF, fire up the choppers!”  In fact, I am arguing the exact opposite.  It is now incumbent on the proponents of the policy to explain why, this time, it should really work.  And why the massive fiscal and monetary stimulus applied in Japan, including in its latest Abenomics form, has failed to generate a heartbeat.

Until the proponents of helicopter money meet this burden of proof, my views have been nicely summarized by John Hussman, the investment manager and former professor at the University of Michigan, who included these words in one of his recent updates:

I continue to view the intentional distortion of the financial markets by the Federal Reserve to be a reckless mistake. These policies have produced no benefit to the real economy (output, employment, industrial production) compared with what could have been predicted solely on the basis of non-monetary variables. But these policies have fueled the third financial bubble since 2000; they have elevated security valuations to the point where both stocks and bonds are now priced to produce negative expected real returns for investors on a 10-12 year horizon; they have facilitated heavy issuance of corporate debt with a preference for low-grade “covenant lite” obligations; they have provoked speculative capital flows and “carry trades” in international markets; and they have encouraged competing behavior by central banks across the globe – all from whence will emerge the next financial crisis.

Bootleggers and Baptists

This expression was coined by economist Bruce Yandle, who is currently a faculty member at Clemson University and who worked on regulations during the Ford administration.  He focuses on “public choice” theory, the field of economics, founded by Nobel Prize winner James Buchanan, which explains why the answer to imperfect markets is almost never even more imperfect government.

The expression refers to the tendency of two, otherwise completely antithetical, groups to unite in support of regulations that are against the general interests of the public.  The groups are the true believers (the Baptists) and the self-interested (the Bootleggers).  The first campaigns against some alleged evil – such as drinking – and is the acceptable, public face of the effort.  The second quietly benefits from the resulting distortions of supply and demand.  In certain advanced schizophrenic cases, the Baptist and the Bootlegger can inhabit the same body.  Yes, Elon Musk, I am thinking of you.

Yandle has recently given a speech at the Mises Institute on this subject.  The beginning is a bit to slow and can be safely skipped.  The discussion of regulation starts at about minute 32 with a quote from Cass Sunstein, the Harvard Law School professor and BloombergView columnist whose reflex statism I have previously derided.  Bizarrely, Sunstein invokes Friedrich Hayek, whom he has clearly totally misunderstood.

Yandle makes an interesting point on the rise of “command and control” regulations, which mandate precisely how to achieve a desired outcome, instead of providing goals or incentives and letting the private sector figure it out.  This is the most expensive kind of regulation, but Yandle notes that it represents “victory” for the rent-seeking Bootleggers.

Yandle points out (at about minute 45) the insidious nature of the Obama regulatory regime.  A textual analysis of Federal regulations shows that, through the first six years of Obama, he is leading previous administrations in the implementation of new “command and control” regulations.  Yandle also points out that all administrations, Republican and Democratic, have a noticeable tendency to promulgate even more rules during their last year in office.  So, we can expect the Obama lead to widen.

Yandle also notes that, contrary to the executive order instructions of all previous administrations, Obama has instructed his regulators to consider matters such as “fairness” and “equity” when determining regulation, in addition to the traditional requirement for a cost-benefit analysis.  Why he thinks that unelected regulators should or can make these judgements is just another mystery of the unfathomably deep thinking of BHO.

Middle Class Struggles

I have just read an article entitled “The Secret Shame of Middle-Class Americans” in The Atlantic.  The article chronicles the quiet desperation of a fairly successful writer who now finds himself in tough financial straits after following the usual path to middle-class respectability.  He claims that this is the situation of many seemingly middle-class Americans, who are just too ashamed to talk about it.

After lots of statistics on stagnating wages and the lack of savings and wealth, here is the interesting paragraph:

If there is any good news, it is that even as wages have stagnated, a lot of things, especially durable goods like TVs and computers, have been getting steadily cheaper. So, by and large, has clothing (though prices have risen modestly in recent years). Housing costs, as measured by the price per square foot of a median-priced and median-sized home, have been stable, even accounting for huge variations from one real-estate market to another. But some things, like health care and higher education, cost more—a lot more. And, of course, these are hardly trivial items. Life happens, and it happens to cost a lot—sometimes more than we can pay.

After pointing out how the relatively unfettered private markets and globalization have driven down the cost of a wide range of products, with a corresponding increase in standards of living, the author makes specific comments about three things: housing costs, health care and college educations.  It is absolutely no coincidence that these are three of the sectors where perverse government policies are most at work, as pointed out here, here and here.

I strongly suspect that this author’s tale is not unique.  Slow wage growth is a problem, but what is really crushing the middle class is government-mandated cost inflation in these three key sectors.

Roger Barris

Weybridge, United Kingdom

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Posted in: Economics, Policy

Comments

  1. Reuven Brenner
    May 1, 2016

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    Roger, hi:

    you mention that AT piece. But you’ll find a more extensive piece few years back in The International Economy, that also answers some other questions you raise:

    http://www.international-economy.com/TIE_F13_Brenner_Fridson.pdf
    a shorter version of the above was also in WSJ few years back:

    http://www.wsj.com/articles/SB10001424127887323393304578364661082431422

    PS. No, am not head of any “economics department.” Back in 1998, when Forbes did a cover story about my endeavors, they titled a sidebox “Just do not call him an economist.” I happen to disagree with almost everything economists do these days, and not only in “macro-economics,” the latter in my view is sheer astrology. I am serious: take a look at Chapter 1 in World of Chance (Cambridge UP 2008).

    • Artus Barris
      May 1, 2016

      Leave a Reply

      Please excuse me for the mistake as that misinformation has been spread by me. The blog post has now been updated.

    • Roger
      May 13, 2016

      Leave a Reply

      Hi Reuven:

      Thanks for your comments and thanks for sending along your additional articles. I see that my son has corrected the reference to your current position — apologies for that.

      I have read your article in International Economy with interest. In particular, I like the comments about the distortionary effects of the Fed’s policies and the political implications of these. This has been a major theme of many of several of my postings and is without a doubt one of the worse byproducts of this policy.

      There is another comment in your article that I found interesting. And that is the comment about the changes in 1989 eliminating the “rents” that Western workers have been able to earn for decades. I get the argument and this dovetails with something that I have been thinking about lately: We have many, many stories of people losing a high-paying manufacturing job (often through outsourcing or foreign competition) who are only able to replace it with a low-paying position, often in the services sector. But this is bizarre and not the functioning of a normal economy. The only reason why a worker should be earning so much more in one position than in an alternative one is if he has job-specific knowledge (human capital) built up in the first position. But if the first position required lots of job-specific, human capital, then by definition it should not be easy to outsource or replace with a foreign supplier. However, this fact pattern is consistent with your claim that much of the compensation in the first position is “rents.”

      This is a logical economic explanation, but the political/social implications are horrific. Any thoughts?

      Roger

  2. Reuven Brenner
    February 8, 2017

    Leave a Reply

    Roger, very long silence, very hectic.

    Yes, that has been my point, you can find more detailed arguments about this in some of my Forbes columns years ago. Am not sure though that the implications are necessarily horrific – if proper policies were pursued (which they not have been). Take a look at my First Things pieces, you could infer some answers, and more, in a concentrated form in a new publication American Affairs, to be launched Feb 21 in NY (Peter Theil and other backing it), and they asked me to contribute on fiscal policies to the first, on monetary to the second volume, this summer.

    If interested in my far broader view of things, last summer was invited by the Pres of Poland to advise on issues linked to VC; and on that occasion the John Paul 2 Institute asked me to give a speech on a topic they imposed (they read my books on history, my unusual Biblical interpretations etc.). They uploaded the entire 2 hours (talk and Q&A) not in very good resolution on youtube. You can hear the Head of the Institute comparing the impact of my work to that of JP2 … (in general, if people in finance are compared to Popes, it would be the Borgias …). If you wish speedier reactions, you can send me e-mail. No, I have no time for blogs, facebook, websites etc. Sorry. But I do answer emails. Reuven (PS. you can google my name, click news and you can find some recent brief articles).

    • Roger
      February 15, 2017

      Leave a Reply

      Thanks, Reuven. I will check some of the additional sources you mention and get back to you if I have any questions/comments, via email (which is also my preference — I am a reluctant user of blogs, social media, etc.). Meanwhile, my son continues to enjoy your university. Be well.

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