Helicopter Money (Part 2)

What’s wrong with helicopter money?

Photo: Eric Salard. Source: Wikimedia

“Helicopter money” is money created by the central bank so that the government can spend it. It typically happened during wartime: the government unmoors the currency from a gold or silver standard, and the central bank credits the government’s financing agency the funds. Governments do this when their very existence is threatened, when war or insurrection require them to raise a large army and buy a lot of material.

The result is always inflation: more money chases the same amount of goods, so the price of those goods has to rise. And that’s the whole point. In our slow-growth stuck-in-the-mud economy, prices are stuck, too. Inflation has been about 1%. Should the economy falter, they could start to fall. And deflation could be disastrous, threatening the financial system. The government needs to have a way to fight it.

So what’s wrong with this approach? 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 in order to be free to take the punch bowl away when the party gets too hot. Second, it’s unlikely that a one-off increase in spending would boost the economy very much. People aren’t stupid. They know that what the government gives, the government can take away, one way or another. We know what happened to the tax-rebate checks issued in 2008 and 200. Only about 20% of it 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 resorted to printing more money, and the result is hyperinflation. Prices don’t just gently rise, they spiral up out of control. Examples are abundant: Peru in the ‘80s, Yugoslavia in the early ‘90s, Zimbabwe in the mid-2000s, Germany in the early 1920s. 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. Source: Wikipedia

Helicopter drops don’t work because if they don’t persist, the money is saved, and if they do, inflation gets too high. 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.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2019-02-20T13:04:45+00:00April 27th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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