Wednesday, July 20, 2016

What Is Helicopter Money?

It seems as if we move every few weeks from a cliche topic that hums throughout the financial headlines to the next. A few weeks ago it was "Brexit," then it was the "Italian Banks," and now it's "helicopter money."

While the Italian banks are a real concern and something I will address again in detail in the future, I want to take a brief moment to walk through my thoughts on helicopter money.

First of all..what is it?

Ben Bernanke gave his now legendary speech in 2002 titled "Deflation: Making Sure "It" Doesn't Happen Here." It described how the United States would fight deflation should it enter a credit crisis like the one we entered in 2008. The speech has become the playbook the Federal Reserve has used since March of 2009; interest rates brought to zero in combination with quantitative easing (printing money to purchase mortgage and government bonds).

Other central banks have copied these strategies and are even pushing their boundaries further. The European Central Bank has taken rates negative, and the Bank of Japan has expanded on the types of assets they purchase with their QE program (stocks and corporate bonds).

The goal of all these strategies is to entice lenders to lend and borrowers to borrow. They want to make it very appealing for all borrowers (governments, banks, corporations and individuals) to take on new debt, which they believe will help juice or stimulate the economy.

The problem is very little of the money has found its way into the real economy. The Fed has purchased trillions of dollars of government bonds from banks and the banks have taken most of that money and parked it right back on the Fed's balance sheet.

Corporations have taken the opportunity to borrow money at extremely low rates, and instead of reinvesting the money into corporate growth (which would create new jobs and feed money into the real economy) they have used the funds in large part to repurchase their own shares and issue larger dividend payments. This serves to drive the price of stocks higher, which pads the bank accounts of corporate executives and those that already own stocks (the rich).

Money has been lent out to investors to purchase commercial real estate at extremely low interest rates and extremely high prices. This helps all investors that currently own commercial real estate. Low rates have made home ownership more attractive as well, pushing more renters into the market and creating the opportunity for hedge funds to purchase and rent out large swaths of single family homes. Both those factors put a floor on home prices in 2012 and have driven them back up to pre-bubble highs in many cities.

Bonds have entered a realm all to themselves. As the main target purchases for central bank QE programs, bonds have become a true speculative mania worldwide.

In essence, the central bank policies have created asset bubbles in everything. Unfortunately, while the price of financial assets are all simultaneously sitting at record highs the the real underlying economy to support those prices has not come along for the ride. Growth and real wages have been stagnant and in some cases declining in many parts of the world since 2008.

So why is a "helicopter money" program different from the programs that we've already tried? It combines government spending with QE progams. In effect, it pumps money directly into the economy by:

- cutting taxes
- infrastructure projects
- boosting military spending
- increasing welfare spending
- etc. etc.

Programs like these put money directly into the hands of everyday citizens. They do not have to borrow the money to receive the benefit. These programs would then be "paid for" by central banks who will print the money and purchase the bonds the government must issue to finance the spending.

For example, the U.S. federal government could announce it would be creating a $1 trillion stimulus program in 2017. The Fed would make a simultaneous announcement that it will be purchasing $1 trillion in government bonds in 2017. That is helicopter money because it is essentially being dropped from the sky by central banks directly into the real economy.

While the markets have become very excited by the idea of a coordinated helicopter drop around the world there is one major problem they are forgetting. Central banks can act immediately, create new programs and essentially do whatever they want with no supervision or need to ask for permission. Government spending does not work that way. Stimulus programs must be voted on by elected officials in order for them to be put into effect. What do you need for that support? The public to want them to do it.

Everyday Americans have trouble understanding what central banks are doing and what the long term consequences are on the economy and financial system. They do not realize how they have pushed asset prices into dangerous bubble territory, and many can't connect the dots to see how low interest rates steal from savers and retirees. It is a confusing and multi-layered process and central banks like it that way. 

On the other hand, it is very easy for everyday Americans to understand government spending. They see a $19 trillion deficit in America and they immediately realize (through common sense) that additional borrowing which cannot be paid back will ultimately cause a problem. Therefore, there is natural discomfort that builds when new spending programs are announced.

So what do you need to overcome this anger? Pain. When the government announced they would be borrowing $800 billion in the fall of 2008 to bail out the large banks there was outrage, but people were looking around and watching the value of their homes fall, their stock portfolios drop and many were losing their jobs. While most did not fully understand what was happening, they knew "something had to be done" in order to try and stimulate or save the economy.

The same type of pain will be needed for helicopter drops to be put into effect. This is why a market crash will likely need to come first, before the public is okay with the action or even begs for it. 

There will likely be a lag period from when the helicopter money discussions begin and when they are actually implemented. That lag period will likely not be a good time to own risk assets. 

For those that have been patiently waiting for real consumer price inflation to arrive (we've only had asset price inflation so far), helicopter money will deliver. When prices rise and interest rates on bonds must compensate for rising inflation (rising interest rates rise), we will see the arrival of the real financial crisis. Ironically, the inflation central banks want so desperately to create will ultimately be what pops the global bond bubble and creates an unstoppable financial Armageddon.