Helicopter Money

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by: Douglas Tengdin, CFA


Helicopter money is money-financed government spending.

Unless it is permanent, Helicopter money is unlikely to stimulate spending.

The result of monetary finance is hyperinflation.

What is helicopter money?

Photo: BegoBego. Source: Morguefile

"Helicopter money" is a concept first floated fifty years ago by Milton Friedman, where he proposed - theoretically - that the government fly over a community and drop thousands of dollars, financed by the central bank. What would that do to the economy, he wondered. This notion was revived by Ben Bernanke in 2002 when he gave a speech on preventing Japan-like deflation here in the United States. The speech earned him the nickname "Helicopter Ben."

In a recent blog post, Bernanke revives the idea as a potential tool of the central bank. Obviously, he didn't suggest fleets of Sikorskys flying over the country. But a money-financed tax cut or spending boost would be essentially the same thing. In technical terms, "helicopter money" is an expansionary fiscal policy financed by a permanent increase in the money stock. It's an increase in public spending or a reduction in taxes paid for by a permanent increase in the Fed's balance sheet.

To effect this, the central bank would credit the U.S. Treasury's "checking account," and those funds would be used to pay for the spending. Alternatively, the Treasury could issue zero-coupon perpetual bonds, which the Fed would buy. This would have a number of effects:

First, households would have more money, either because there's more employment on government projects or because after-tax pay goes up. The bigger the helicopter-drop, the bigger the impact on wealth. Second, if spending goes up, inflation would pick up. When more dollars chase the same amount of goods and services, prices-the clearing mechanism-have to increase. You can't repeal or suspend the law of supply and demand. Third, because the spending is financed by the Fed, there would be no expectation of future tax increases; there's no way for them to shrink their balance sheet back down. All this is intended to boost the consumer spending.

Bernanke concludes his piece by saying that helicopter drops aren't very likely to be needed in the US. We still have a growing economy and moderate inflation. In fact, there are some signs that inflation is picking up right now. This sort of thought-experiment is kind of like physicists thinking about trains and elevators moving near the speed of light. It helps build our understanding of how things work.

But we know that light-speed trains are impossible. Helicopter drops - money-financed government spending - are quite possible and have been used many times throughout history. And the result is always the same: hyperinflation. It's not pretty. Let's hope we don't go there.

Why wouldn't a heli-drop work?

First, it would require close coordination of the central bank and the administration. That's something we don't want. Central banks need to be independent and free to take the punch bowl away when the party gets too hot. Second, a one-off increase in household wealth wouldn't boost consumer spending much. very much. People aren't stupid. They know that what the government gives, the government-or inflation-can take away. Look at what happened to tax-rebate checks issued in 2008 and 2001. Only about 20% of that money was spent. That's not much of an effect.

Finally, we've seen the end-game of money-financed spending. Countries running out of funds have frequently resorted to printing more money, and the result is hyperinflation. Prices don't just gently rise, they spiral out of control. Examples are abundant: Peru in the '80s, Yugoslavia in the early '90s, Zimbabwe in the mid-2000s. Prices increased by more than 50% per month. This happens because people know the money is unmoored from any notion of value. If the central bank thinks it can keep this genie in the bottle, it is mistaken.

Price of gold in Weimar Germany. Log scale. Source: Wikipedia

Helicopter drops don't work because if they don't persist, the money is saved, and if they do persist, inflation gets out of control. It's always a temptation for technocrats to think that they can manage the process-that it's different this time. But it's never different this time. Free money just isn't free.

A case in point today is Venezuela. They don't even have enough money to pay the people who print their money. Late last year, the Venezuelan government needed to satisfy a growing currency shortfall. In December Venezuelans throng to the banks to cash in their bonuses, and like everything (but oil) in their economy, bank notes have to be imported.

Instead of inviting printers to bid for the job, the central bank told several of them to produce as many notes as possible-to run their printing presses flat-out. The companies filled the order-but haven't been paid yet. They want to be paid in hard currency, not Bolivars, and for the last year hard currency has been in short supply. Last year Venezuela imported more than 10 billion bank notes, 30% more than were printed in the US - and they have an economy less than 3% the size of ours.

The result is the world's highest inflation rate-currently 180%. Usually, when prices spiral like this, countries start adding zeros to their bank notes. Venezuela is going into uncharted waters by not printing larger bills while not paying its printers, either.

Source: Bloomberg

Now, people have to use wheelbarrows of cash to buy basic goods. We know where this ends. In 2005 Zimbabwe's economy spontaneously dollarized after its hyperinflation. Maybe Venezuelans won't trust gringos with their money-there's too much bad blood between our countries. But for everyday commerce to continue, they need some sort of hard currency.

Maybe yen?

Disclosure: I am/we are long THE MARKET.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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