- Japan is flirting with new and more aggressive monetary easing.
- Inflation in the U.S. might already be higher than officially reported.
- Further monetary easing could be beneficial if, and only if, it stays under control.
We live in very interesting financial times. With low inflation, central banks are able to inject lots of money into the economy through asset swaps, and still keep interest rates low.
Figure 1: FED balance sheet and S&P 500. Source: FRED.
In theory, more money should mean more growth. Since there has been no inflationary consequence thus far, why shouldn’t central banks just keep injecting the economy with more money?
Figure 1 shows how the increase in available liquidity has influenced asset prices by lowering risk aversion, as the S&P 500 has moved in lockstep with increasing liquidity.
Since there has been no visible inflation, a rumor that central banks might inject even more money into global economies by using so called “helicopter money” is now circulating among certain financial circles.
This article is going to introduce you to what “helicopter money” is, what the real risks of it happening are, what the impact will be on your portfolio, and discuss some investment ideas if it really happens.
What is Helicopter Money?
“Helicopter money” is an idea made popular in 1969 by the great American monetary economist Milton Friedman in his paper “The Optimum Quantity of Money” where he shares the following:
“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.”
The idea is that if you receive more money, you will spend more and thus bring inflation to the target rate. As printing money is done at a minimal marginal cost, there are no constraints on central banks, however, they have not yet resorted to such a measure. The latest rumor of using “helicopter money” was started after Former Federal Reserve Chief Ben Bernanke visited Japan and discussed more creative and extreme monetary policies. The first consequence of more monetary easing is currency devaluation. And last week, just the rumor of more easing saw the Japanese Yen depreciate by 5%.
Figure 2: JPY per 1 USD in the last 7 days. Source: XE.
No monetary policy seems to work in Japan and its central bank has reached its limit of “asset purchases.” There may be no other option for Japan than to get creative with “helicopter money.” If Japan pulls the trigger, other global economies will follow in order to stay competitive.
Consequences of Helicopter Money
The main consequence of such bold moves would be even more uncertainty. We already have negative interest rates and ballooned balance sheets, for which we have no historical precedent, the same holds for “helicopter money.” With no hard evidence all we can do is guess how such an experiment will end.
The first signs of increasing uncertainty will show up in the currency markets. Figure 2 above showed that even the mention of new monetary measures in Japan sent the Yen 5% lower against the dollar.
“Helicopter money” is always a bad idea with negative long-term consequences, even though in the short run it may provide a “boost” to the economy. Let’s not forget, the same argument was used for the current easing monetary policies, which have yet to “boost” the economy. When easing didn’t work, central banks and politicians opened the easing spigot even more. The same temptation would exist with “helicopter money” and could get completely out of control.
If central banks choose to deploy “helicopter money,” their only focus should be to reach the 2% inflation target for Japan, Europe or the U.S., which according to the FED has not yet been reached.
But increasing the money supplies can become a “monetary addiction,” since it makes it easier for any government to repay its debts and go deeper into deficit spending, which always helps to get reelected. With the coffers full of new money, much less thought is given to the need to repay debt.
Figure 3: U.S. Inflation rate. Source: U.S. Inflation Calculator.
Even though the Fed says the 2% inflation target has not yet been met, other sources state that the inflation rate is much higher than what is officially reported. The common consumer price index (CPI) is a questionable measure of inflation as it tracks consumer spending and not the real supply of money. The current money supply has been constantly growing which means money is worth less. What’s misleading is the fact that the constant increase in money supply has not translated into higher prices in the last few years.
Figure 4: M2 money supply vs. CPI. Source: FRED.
As the CPI measuring method constantly changes, it’s a good idea to take a look at inflation that doesn’t take into account measuring method changes since 1980. The shadow stats rate of inflation is much higher than official, and in line with the above increases in money supply.
Figure 5: Constant CPI method inflation. Source: ShadowStats.
The true definition of inflation is an increase in the money supply, which always makes it worth less, regardless of what current economic indicators tell you. Rising prices are just a symptom of inflation, and more money put into the system might spur hyperinflation, should central banks decide “helicopter money” is the road to take.
How Will Investments Behave?
With more money flooding the system, the current asset inflation would just continue. However, there will be sectors that outperform.
As governments start “dropping” money from helicopters, infrastructure companies should be some of the biggest beneficiaries. As more infrastructure gets built, it requires more materials. Since there is a limited supply of commodity resources, it’s inevitable that with more money in circulation, prices rise. Therefore, materials can protect and hedge against inflation.
We don’t know when and if central banks are going to pull the trigger on more monetary easing, but it is a good idea to consider such a scenario and how it could affect the global economy and various investments.
If Japan starts with “helicopter money,” investments there might increase as the Yen devaluates since the revenue of many of Japan’s corporations is derived abroad. A weaker yen also promotes their exports. If “helicopter money” appeared to be working in Japan, Europe would quickly follow since the other forms of monetary easing haven’t achieved the desired result in either country.
In the short run, any additional monetary easing efforts should benefit all equities, which has been the case over the last 7 years. But in the long run, if the easing is not done “properly” (can we expect politicians and bankers to behave properly?) it is almost certain to bring long lasting economic troubles, similar to those Japan has experienced over the last 20 years. One has to wonder why they think more of what hasn’t worked is the best solution.
Historically, all money printing experiments end badly. One of the worst resulted in a World War as Germany was looking for a way to exit its hyper-inflationary crisis. The 1924 100 billion Deutsche marks banknote is an indication of how monetary easing can easily get out of hand.
Figure 6: German 1924 100-billion-mark note. Source: Solingen.
We can hope that monetary easing doesn’t get any more out of control than it already is. And that it only continues to inflate asset prices and increase investment returns, as it has done for the last 7 years. But don’t bank on it.