Have you ever played Monopoly and everyone was in such a terrible situation that you all decided to distribute a certain sum of money from the bank to all players? Well, you are not the first…
This unorthodox monetary policy was firstly introduced by the Nobel prize Milton Friedman in “The Optimum Quantity of Money” (1969) where he tried to assess the consequences of a one-time distribution of a lump sum to citizens, bypassing the middleman. In his famous example, a helicopter would fly over the community dropping piles of banknotes; the nickname of “helicopter money” comes right from there. Its purpose is injecting money directly into people’s pocket, which should result in boosted aggregate demand and an increase in the inflation rate. Recently this concept got a surprisingly amount of attention in the Euro area as standard monetary policies and QE proved to be not sufficient to bring inflation level below, but close to 2%.
But how can helicopter money be possibly introduced today? Ben Bernanke (former FED’s Chair) suggested in 2002 a tax rebate financed by government bonds concurrently with an asset purchase program to keep interest rates down. Does it sound like QE? Yes, but the main difference is that thanks to the tax relief, the transmission of the benefits of this policy fall mainly on the private sector. The other way to implement it is with a direct transfers into people’s bank account, but this situation, which is the most radical because the central bank would be substituting the Treasury, presents more concrete problems: who should get this money first? What are the bureaucratic cost to sustain such an operation? What about those who do not have an account?
How to trade it
Now, what are the concrete implications for investors? To understand what and how to trade, it is paramount to understand first the drivers of interest rates.
The downward pressure on yields will be brought by:
- Direct money for governments, that results in an abrupt fall of sovereign credit risk
- Lower supply of bonds and the perception that the central bank will continue to buy assets under QE
The upward pressure will be brought by:
- Higher growth and inflation expectations
Then, as for all policy implementations, especially for innovative ones, the market can perceive it positively or not, and it is exactly for the two different market perceptions that different scenarios arise. On one side, perception of failure would make the growth and inflation expectations drivers weaker than the credit risk and demand/supply imbalances. Hence, the downward pressure on yields will dominate. On the other side, perception of success would provoke the opposite reaction, which will drive yields upward. It is also crucial to keep in mind that the policy could be perceived as a loss of monetary discipline; and therefore inflation expectations will spike leading to authorities having to re-adjust nominal rates higher, that in turn will just reduce investments and not bring enough of the growth desired.
Usually, real interest rates are the main drivers of the currency, which means that currency should follow the same path as the real yields. Nevertheless, simple macroeconomics teaches that a permanent increase in money supply will lead to a weaker currency.
The effect on equities is ambiguous too, in the sense that growth and yields move the price in opposite direction. Overall, this unorthodox policy should bring considerable growth and moderate interest rise, and thus, equities should rally.
As you have noticed, success of helicopter money must not be taken for granted. A clear evolution of the correct implementation should lead to inflation expectations together with the central bank committing to keep nominal interest low, in the first period of the policy; and then, when growth spurs, a tighter monetary policy should be adopted. This process will lead to higher interest rates, weaker currency (initially), and higher equity prices.
Currently, helicopter money has only been theorized without any real implementation. Most probably, the reason is that it is far too risky: once money is “gifted”, it is not possible to retrieve it back; leading to excessive money supply. Even if policymakers were willing to take on this risk, there are other factors that would restrain them; mainly the coordination between governments and their independent central bank. In fact, all major countries such as US, UK or Japan have regulations that prohibit any direct financing of government. Notice though, that some countries already adopted previously deemed unrealistic policies, such as the NIRP. Therefore, it is not unthinkable that they may try to use helicopter money in the upcoming months.
Still, on Wednesday 20th of April, BoJ Gov. Kuroda said: “Unless the existing legal framework changes, helicopter money is not possible, and we at the Bank of Japan aren’t thinking about it at all.” Notice that, it is totally different from saying: “Only lunatics would implement such a destroying-economy policy”. Hence, it is not totally out of mind to consider a future adoption of helicopter money by the Bank of Japan. Reason is, that the BoJ has tried everything to boost inflation and growth; everything, except for helicopter money. Regarding coordination between the government and the independent BoJ, the National Diet (Japanese legislature body) prohibits the direct finance of governments, but it allows for exceptions. In addition, the past suggests that Kuroda favours surprises to the market. In fact, on January 21st he conveyed that he did not plan to adopt negative rates, while a week later, on January 28th he actually adopted them, stunning the market with surprise.
In UK, on Tuesday 19th April, BoE Gov. Mark Carney said that helicopter money was “absolutely in the hypothetical”; in Europe, on Thursday 21st of April, ECB Gov. Mario Draghi liquidated a question about helicopter money with only a “We have never discussed it”. Given these premises, we have only to wait and see what is going to happen.