MD Salt Fund Management
As the ancient curse goes, “may you live in interesting times”. These interesting times of Covid-19 have given NZ and many other economies a problem. Governments have eased fiscal policy with admirable speed and flexibility but are ultimately constrained as rising debt will have to be repaid by future generations.
At the same time, central banks have slashed interest rates to near zero and engaged in wholesale quantitative easing (QE). This has proven a boon to financial markets, with US equities, for example, experiencing the most rapid bear market in history and then shaking in off in just a few days to re-enter a bull market.
While financial markets and the top end of town have been rescued, remarkably dire forward indicators raise major doubt as to whether this will feed through to the real economy. NZ equities have also rallied hard but the outlook for jobs and incomes is dreadful. The counter-factual of no central bank action would have been even worse but how do you help Main St rather than just Wall St?
NZ’s wage subsidy scheme is working well due to its immediacy. It is clearly saving jobs by shovelling money out the door to businesses in need. The RBNZ’s Business Finance Guarantee Scheme will extend loans to small/medium businesses, while assuming 80% of the loan risk, with banks only retaining 20%. This is promising although it remains to be seen how well it will work in practice when the issue for many businesses is a collapse in revenue. It is this revenue rebound that is necessary but the scheme may provide a useful bridge to get to that point.
The RBNZ has cut the OCR target from 0.75% to 0.25% and has introduced QE. They are initially buying government and local authority bonds with the aim of holding down long-term interest rates. The door has been left open for this to be expanded. The US Fed is run by a former private equity manager and the affinity for Wall St shows. Their QE now extends into sub-BBB- rated junk bonds, with equities perhaps next on the menu. This has seen previously ballooning credit spreads come in and semi-frozen funding markets open back up.
This is all necessary and Wall St has applauded but Main St looks awful. Everything I read is about firms laying off people, delaying bill payments and trying to renege on rental contracts. That is what happens when there is no revenue. Unless central banks can somehow get the monetary medicine through to Main St, there is a huge risk that the temporary shock from Covid-19 will turn into a permanent loss of output and jobs. While applauding the actions taken in NZ to date, the fear is that they are merely necessary rather than sufficient.
So, how can RBNZ actions filter through to real people and jobs? They are sending the monetary base into the stratosphere but the velocity at which that money turns over has collapsed. The classic monetarist identity of MV = PQ holds good. The amount of money (M) times the velocity (V) at which it circulates must equate to prices(P) times output(Q). V has collapsed taking prices(P) and especially output(Q) with it. Expanding M is helpful but it is not enough.
One possible answer is the heretical concept that former Fed Governor, Ben Bernanke tabled as a last resort in a famous speech in 2002 – “helicopter money”.
The idea came from Milton Friedman in “The Optimum Quantity Of Money” (1969), with a thought experiment in how one need never give in to deflation:
“Let us suppose that 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.”
In Bernanke’s famous speech reviving this idea in 2002, he argued that as monetary policy faces diminishing returns from lower rates and QE, “monetary financed fiscal policy could prove a valuable tool.”
How might it happen? While a physical helicopter drop would be great fun, one simple way would be to electronically credit $1,000 of brand-new money into the account of every individual with an IRD number. If that doesn’t work, then repeat.
If one prefers big government, then another way would be for the RBNZ to finance fiscal deficits for the next year or two by buying (and never re-selling) government bonds with newly minted electronic money. The UK recently expanded its “ways and means” account at the Bank of England to potentially pave the way for exactly this policy.
So long as we can issue bonds in our own currency, we can do this. Strict controls and time limits would be needed lest our economy becomes addicted to the seductive drug of money printing once the one-off crisis subsides. We do not want Gideon Gono running affairs.
This policy might also lead to a welcome increase in the velocity of money by individuals and firms. In the extreme cases of Zimbabwe and Weimar Germany, money had to be spent almost instantly before it devalued and a trillion dollars was needed to buy a loaf of bread.
This also illustrates the extreme danger of this policy if it runs remotely beyond strict pre-set limits.
One might ask what is wrong with normal debt-financed fiscal expenditure by the Government, especially at a time when interest rates are at record lows and will likely stay there thanks to QE. This is a fair question but ultimately the debt needs to be repaid, regardless of whether the funds are invested productively or wastefully. Lags in implementing infrastructure investment may mean the rubber finally hits the road at a time when the economy is naturally rebounding anyway. Activity is needed now not in two years.
Worse, if the coming slump sees deflation, the debt will need to be repaid with dollars that are worth more in the future than they are today. The debt does not get inflated away like it did after World War 2 or in the 1980’s. Any rational taxpayer realizes that taxes will have to rise in the future to repay this debt and will therefore cut expenditure today. Helicopter money gets around this problem termed “Ricardian equivalence”.
A final advantage is that “helicopter money” might achieve the lift in inflation expectations that has proven so elusive for central banks in recent years. This might occur both from domestic consumers and via a depreciation in the exchange rate.
There is no doubt that the very idea of helicopter money is playing with fire. There is a long history of disaster from the ancient Romans putting less silver in their coins through to Weimar Germany, Zimbabwe and Venezuela. However, current central bank actions are uncomfortably boosting Wall St rather than Main St. Further, Grant Robertson ultimately faces fiscal limits and time lags in the amount of help that he can provide to Main St. The extreme one-off nature of the Covid-19 lockdown certainly meets the criteria for helicopter money. If we reach a dead-end with other more conventional options, then maybe just maybe it could be worth a look?
National Business Review