Last Friday,
we postedwhat we thought was a watershed report
by Australia's largest investment bank Macquarie, one which openly
called for central bank funding of fiscal spending, aka "helicopter
money", by directly monetizing treasuries. Ironically, the bank
made the call despite admitting that it would not work in the long
run, leading to even more stagflation and deflation. This was the
gist:
As velocity of money globally continues to fall, conventional
QEs have to become exponentially larger, as marginal benefit
declines. If public sector is not prepared to step aside, what
other measures can be introduced to support nominal GDP and avoid
deflation?
There are several policies that could be and probably would be
considered over the next 12-18 months. If private sector lacks
confidence and visibility to raise velocity of money, then
(arguably) public sector could.
In other words, instead of acting via bond markets and
banking sector, why shouldn’t public sector bypass markets
altogether and inject stimulus directly into the ‘blood
stream’?Whilst it might or might not be called QE, it
would have a much stronger impact and unlike the last seven years,
the recovery could actually mimic a conventional business
cycle and investors would soon start discussing multiplier effects
and positioning in areas of greatest investment.
British Leyland (formed from nationalized British car companies
in the late ’60s) destroyed its automotive industry but for a time
it provided employment and investment. CBs directly monetizing
Government spending and funding projects would do the same.
Whilst ultimately it would lead to stagflation (UK, 70s) or
deflation (China, today), it could provide strong initial boost to
generate impression of recovery and sustainable business
cycle.
The report was critical for two main reasons:
First, it admitted that the conventional Fed QE approach of
using banks (and excess reserves) as intermediaries, is now widely
accepted as a failure (
as we noted earlier) and that a more "acute"
form of money printing would be required, one which nobody would
mistake for what took place in Weimar Germany.
Second, and even more important to us, was that now that the
seal has been broken on "very serious people" discussing monetary
paradrops, it was just a matter of time before the entire sellside
brigade jumped on board this brand new bandwagon. To wit:
"
will the Macquarie report become the benchmark which the
other penguins will ape as suddenly calls to bypass the banks
become the norm and suddenly every "authority" on the topic, which
so vehemently advocated for QE, admits it never worked from day
one, and instead recommends that the only option left to save the
world is the "nuclear" one?"
Today, less than a week later, we got the first official penguin
in the form of Citigroup, which just released a note titled "Cold
Fusion", which proposes a way to
"transform ineffective monetary into effective fiscal
policy."
See if you can guess what it entails (hint: "
Bernanke's Helicopter Is Warming Up", September
13, 2013)
This is Citi bulletin summary:
With rates at zero, fiscal policy will be needed to offset any
negative shock that hits global economies
The practical way of doing so is for central banks to
indicate that their balance sheets will remain large permanently
and keep expanding if targets are missed …
…opening the door for either additional spending or lower
taxes financed by the central bank
… a (very cold) fusion of Krugman macro, Republican tax and
Bernanke (2002) monetary policies
The policy is rates positive, so the first central bank that
goes down this route will likely see its currency appreciate as the
effects are felt
The details are self-explanatory but here is some more from
Steven Englander:
G10 policy rates are at an all-time low but already investors
are discussing what central banks will do at the next downturn.
There is reason to be concerned – rates at all-time lows and
balance sheets at all-time highs have not generated sufficient
recovery to enable any G4 central bank to begin the normalization
process. The fear is that the downward part of the cycle will start
sooner than expected, precipitated either by China and EM, as our
economists have argued or some other shock.
The first instinct is to say more QE, but if the expansion
of balance sheets so far was not enough to avert a new downturn,
there will be skepticism that additional balance sheet expansion
will reverse a new slump.Moreover, the balance sheet
expansion seems to have been reasonably effective at lowering
yields and pumping up equities, so the slippage has not been
between policy and asset markets but between asset markets and
activity, and there is no strong reason to think this will change.
If these historically low rates were not enough to generate a
durable recovery, it is unlikely that the next 30-50bps will be
enough to counter a negative shock.
To summarize: a recession is coming and conventional QE has
failed. Worse, the Fed backed off its experiment at generating a
reverse-psychological recovery, whereby a rate hike would have been
seen as a catalyst for imminent growth (because what do they know),
so the current arsenal of "tools" is useless.
Well, time to come up with a different tool. Here's Citi:
We now think that the move to central banks endorsing
fiscal policy and essentially monetizing the added spending will be
relatively quick and direct, in the event of a sudden slump in the
global activity.When we wrote earlier on this subject we
arrived at fiscal after other alternatives had been exhausted, but
we now think it can be managed within the current monetary policy
framework of most central banks.
Yes, the chopper.
Continuing:
The argument for fiscal policy via central bank
monetization is that it directly injects purchasing power into the
economy and will increase activity or inflation or
both.QE increases the balance sheet but there is no
guarantee that the increased lending and spending will result.
In consequence many have argued for true helicopter money
which is central bank financed final demand, rather than reserves
creation.
Citi realizes that calling helicopter money by its true name
would be a problem, so it proposes an "innovation":
Our ‘innovation’ here is to suggest that central banks will
invite fiscal spending by announcing that their balance sheets will
stay expanded permanently, or almost equivalently, be
reduced only under extreme circumstances, and that they anticipate
additional permanent expansion if targets are missed. Effectively
this eliminates the government debt from the balance sheet, since
any coupon payments on the debt are remitted back to the government
via central bank profits.
Literally the government is paying itself, which is not a
bad deal if you can manage it.Many central banks are
forbidden to monetize government debt, but governments will
understand that permanent balance sheet expansion is an invitation
to spend more, opening the fiscal channel.
Shorter Citi: it's time to unleash the biggest Ponzi ever, "
which is not a bad deal if you can manage it." If
you can't, it's game over.
At that point all that's left are the political considerations
of how to implement this as policy:
If the government understands that the CB’s QE is permanent it
opens the door to direct fiscal measures and increased demand.
Congress may have different ideas on the virtues of additional
spending, but they could be tempted by the prospect of Fed-funded
tax cuts. There is nothing that forces fiscal policy to be highways
and bridges, rather than low personal or corporate tax rates. There
are plenty of Republican tax cutting proposals that rely on
economic expansion or animal spirits to close the fiscal hole that
the tax cut brings (for example,
http://www.wsj.com/articles/how-would-the-jeb-bush-tax-plan-......).
Combine such a proposal with balance sheet expansion and you have
big-time money financed fiscal stimulus.
Essentially you are combing Paul Krugman fiscal with
Republican tax and Bernanke 2002 {link}
monetary.Government spending and infrastructure could be
used as well, but it is important to understand that fiscal
expansion is not synonymous with government spending.
Politically it is difficult for central banks to outright
endorse monetization of government debt, but faced with another
slump and armed with ineffective policy tools, we expect that
central banks will quickly give the wink and nod to fiscal measures
– the Fed relatively quickly, the BoJ at the drop of a hat and the
ECB with an eye to warding off the growth of anti-euro political
movements. If a central bank wanted absolution for this
move, it could follow a rule along the following lines -- if
inflation is below 1.5% use monetized fiscal policy, between 1.5%
and 3% stabilize the balance sheet, above 3% inflation shrink
the balance sheet (the Englander-rule, if you insist.)
The announcement that the central bank portfolios would
remain permanently enlarged could have an immediate effect on
inflation expectations, in addition to any impact on real
expected interest rates from anticipated fiscal spending. Low
policy rates at the front end and balance sheet expansion
preventing the fiscal injection from pushing up medium-long term
rates are a powerful stimulus combination ( I think this was Jacob
Viner’s recommendation during the Great Depression). The fiscal
spending means that monetary policy is pulling rather than pushing
on a string so it makes both policy tools more effective.
We are not tenured economists but even we can tell you what
would happen to inflation expectations: they would promptly get a
"hyper" prefix.
The rates effect is very likely positive at the medium and long
end as expectations of growth and inflation rise. To get the
maximum activity and inflation boost the central bank may have to
keep policy rates low or zero, so that short-term rates become
negative relative to inflation expectations.
This introduces some ambiguity into the currency effects
but we think that the prospect of normalizing activity and hitting
policy targets will be currency positive.
Of course, if Ponzi schemes worked then every country would just
monetize its debt from day one. At least Citi acknowledges that
there are risks to this lunacy:
There is the possibility that this ends up as an activity
negative if the fiscal easing is promised, but not implemented, as
rates would rise, effectively tightening monetary policy, without
the boost form fiscal.
So generating expectations without follow-through is
dangerous.
Finally, lest Citigroup be accused of urging the end of the USD
as a global reserve currency (because make no mistake, if and when
the US launches the helicopter, this is precisely what will
happen), it hedges:
We view this note as both positive and normative. The positive
side is that it discusses how central banks are likely to respond
if they face a negative shock when rates are already zero, and even
they must be having some second thoughts on the effectiveness of
QE. The normative side is that increasingly the absence of fiscal
policy is viewed as one pf the reason for a less than satisfactory
recovery and we outline a practical way by which central banks
could endorse fiscal policy without fully dropping the idea of
independence and non-monetization.
And just like that Weimar 2.0 is born.
What Citi's "innovative" proposal really means is that the idea
to monetize the debt outright and to "paradrop money" is now being
actively discussed among the highest circles of power, and not if
but when the next recession hits, it will most likely be
implemented.
Trade accordingly.
