Category Archives: Economics

Helicopter Money, will it happen

Helicopter money has been mentioned once in a while over the years but lately more and more people have started to propose helicopter money as an alternative to Quantitative Easing (QE). The expression was first used by Milton Friedman in The Optimum Quantity of Money, published in 1969.

For Friedman, helicopter money was unique event, never to be repeated, which would allow debt reduction and raise aggregate demand. The money would be distributed directly to the people to avoid problems associated with money creation by private banks. Another result of helicopter money is higher inflation, which is desired in many parts of the world at the moment. Or maybe one should say some countries are in desperate need of inflation.

Central banks have tried ZIRP (Zero Interest Rate Policy), NIRP (Negative Interest Rate Policy) and QE but the results have been limited. Can helicopter money solve the problems? A very interesting question but as usual, things are more complicated than most people think. Obviously, the helicopter is just a methaphor. Most likely banks would be used for the distribution of
helicopter money. The money would just magically appear in people’s bank accounts.

But this very simple approach is unlikely to do much good in most countries. A lot of people would use it for consumption, buying goods made in China. It would be good for China, and other countries that export a lot of consumer products but for countries like the US which imports a lot of cheap goods, the benefits would be limited. In order to raise inflation in countries such as the US, multiple drops of helicopter money would be required. But this could very easily get out of control, undermining the trust in the currency and leading to hyperinflation.

Therefore economists have suggested various variations of helicopter money. In some cases helicopter money has been suggested as source for funding government investment programs rather than be given directly to the people. One problem with helicopter money is that it has never been tested, so no one can be sure what the outcome will be. It is very easy to find opponents to any form of helicopter money. But given that QE has not managed to solve the problems, more and more economists have started to talk about helicopter money as a possible solution.

Here it is worth pointing out one important difference between QE and helicopter money. QE, at least if you believe central bankers, increases the money supply temporarily while helicopter money increases it permanently.

So will helicopter money actually happen? Most experts believe the answer is no. At least not yet, maybe further down line. A more likely solution is to try to combine conventional fiscal stimulus and QE. This combination should have the same effect at helicopter money but not being as controversial. Fiscal stimulus would mean that government debt would increase but given that most governments can borrow cheaply this is in most cases not really a problem. That a lot of people like to call it a big problem is another thing. Given that QE can be seen as suspension of government debt, QE would actually make such discussions irrelevant.

Grexit, Is It Possible for Greece to Leave the Euro

Grexit has become a popular expression, Greece leaving the Euro. But is it possible for Greece to leave the euro?

It looks quite clear that the only viable long term solution for Greece is to leave the euro but why is the country sticking to the euro despite years of recession?

Greece had cheated its way into the euro but it looked good anyway. The Greek government was just paying one percent more than Germany for its borrowing. But in February 2010 the newly elected government revealed its predecessor’s financial deception. For the previous year, government borrowings was not as had been said 5% of the annual GDP, it was 15.6%. The Greek economy was collapsing.

Needless to say, the revelations made it impossible for Greece to borrow money. The other euro countries and the IMF lent money but imposed strict conditions. The proposed changes were necessary to get some order in the Greek economy but in the short term the austerity package slowed down the economy even more. It looks like Greece is stuck in a depression.

The Greek economy is simple not competitive enough for the euro. Greece needs a weaker currency. But no country is supposed to leave the euro, no procedures exist for a euro exit. There is a good reason why no country is supposed to leave the euro. If Greece would leave the euro because the country can’t handle the strong currency, then other countries could leave the euro as well. This would start people who have money in countries which have trouble to keep up with the value of the euro to start moving their money to stronger economies. Lenders would demand higher interest as compensation for the increased risk, or may refuse to lend to some countries. This could very quickly force other countries to start thinking about leaving the euro as well.

But what would happen if Greece decided to dump the euro? Replacing the euro with a new Greek currency would most likely make things worse. A new drachma would most likely lose more than half of its value against the euro, probably much more. This would be a disaster for those who has debts denominated in euro or US dollar. This includes the Greek government. Imports would be much more expensive although few would be interested in selling anything to Greece unless they get paid up front.

All this would make the new Greek currency lose even more in value and the only way for the government to be able to pay salaries and domestic expenses would be to print a lot more money. This would cause very high inflation which would make the currency virtually worthless. Everyone would prefer to use euros, dollars or even barter rather than holding the new currency.

The change to a new currency would also become a legal nightmare. An enormous number of disputes if debts should be in euros or in drachmas would follow. Obviously debtors would be desperate to get the debts denominated in drachmas while creditors would insist on payment in euros.

Quite clearly, if Greece would leave the euro, the country needs a massive help package from EU. But that is unlikely to happen if Greece would leave the euro without agreement from the other euro countries. Given that all weaker economies would be suspected to be next in line to leave the euro if Greece left, grexit is not an attractive option for the decision makers in Euroland.

So it looks like Greece is trapped in the euro, the country is not allowed to leave because that would be the beginning to the end for the euro. But the country will be stuck in recession as long as it sticks with the euro.

Japan, what went wrong

Japan was admired by the rest of the world for its economic success for a very long time. But nowadays, Japan is used as a warning instead. What went wrong in Japan?

The success of the Japanese economy after the Second World War is well known. Japanese products were exported all over the world. One explanation for the success was the undervalued Japanese currency. The Plaza Accord in 1985 changes things a little bit. It was decided that the Japanese Yen should appreciate against the US dollar.

This would make Japanese goods more expensive in the US. In order to offset the expected decrease in exports, Bank of Japan decided to change to an expansionary financial policy. Due to the long success of the Japanese economy, the Japanese share and real estate prices were already very high.

The expansionary financial policy created an extraordinary bubble, real estate and stock prices skyrocketed to unsustainable levels. With the benefit of hindsight, it is easy to see the overheated economy with ridiculously inflated asset prices but as long as everything keeps on going upwards it is easy to get excited and forget that all bubbles will sooner or later burst.

Once the bubble burst towards the end of 1990, the Japanese economy started a decline which would go on for two decades. The reason for this is easy to explain, the Japanese banks had lent far too much money for buying assets at highly inflated prices. Once the asset prices crashed, the borrowers either went bust or got stuck with huge loans. Since asset prices had decreased too much, borrowers could not sell the assets to pay off the loans.

So why have the Japanese banks not seized the assets from lenders who can’t repay their debts? Well, that would only depress assets prices even more. And the amount of bad loans would most likely force many of the banks to ask the government to bail them out. The most painless solution was to not force debtors to pay or take their assets but that created a sort of zombie economy with banks and companies which in essence were bust but kept on going anyway.

This has kept the unemployment down and prevented a huge crash. But the recovery has taken much longer than anyone had expected.

One way out of a recession is increased consumer spendings. But the Japanese have preferred to save a lot of their income rather than go shopping. In a recession people often cut down on their spendings and try to save money instead. After all, in a recession unemployment goes up so it makes sense for people to build up a buffer.

Since neither the Japanese consumer nor the companies have been spending enough to get the economy going, the government has stepped in and increased its expenses in order to prevent the country from entering a deep depression.

That the Japanese prefer to save money rather than spend it is a mixed blessing. The Japanese government has been able to borrow a lot of money without paying any penalty interest rates. In 1991, the government’s debt was 66% of the annual GDP. In 2012 it had grown to a whopping 214%. Italy, often mentioned as a warning, has a debt of 126% of the annual GDP. If the Japanese government had not been able to borrow from Japanese households and companies, it would probably have gone bust by now.

The ageing population in Japan does not make things better. But the main problem was that after the bubble burst, the sinking assets prices stalled the economy. Japan has tried different ways of getting the economy going again but it looks like without inflation, which would increase asset prices, not much happens. This is why quantitative easing has become a popular solution for several central banks.

Money Printing in 2013

You hear a lot about central banks printing money at the moment. Everyone knows excessive money printing leads to higher inflation, in worst case to hyperinflation. But at the moment, most central banks are more worried about deflation than inflation. Here is a summary of the central banks current strategies.

Several large economies have adopted quantitative easing, QE. Some critics mean that quantitative easing is the same as money printing. The central banks on the other hand have pointed out that quantitative easing is not the same thing as traditional money printing. Quite clearly there is a difference between QE and money printing. While traditional money printing always expands the money supply, QE may not expand the money supply much.

But even if QE is not exactly the same thing as money printing, should not the huge amounts of QE money increase the inflation? It is impossible to answer that question, QE is an experiment and nobody knows how to end a quantitative easing program. You can read more about quantitative easing and inflation here.

The most important central bank in the world is of course the Federal Reserve in the US. The world has become used to huge US trade deficits that boost the economies all around the world. The US economy got into big trouble in 2008 when the credit bubble burst. The Fed cut lowered its interest rate to almost zero but that did not help. The only thing left that could avoid a deep depression was the printing press, in the modified form of quantitative easing.

The first round of quantitative easing in the US did improve the solvency of the banks and help to push the stock markets upwards. But the economy had not improved so the Fed announced a second round of quantitative easing. The decision was probably forced by the fact that the stock market had dropped almost 15% since the end of QE1. At the end of QE2, the economy was still on government life support and this time Bernanke announced an open-ended QE3.

At the moment, the Fed is buying bonds for $85 billion per month. It looks like this is set to continue, as soon the Fed starts to talk about scaling down on quantitative easing, the markets start heading south. As many have noticed, the markets should really be happy that QE is over. QE is a temporary emergency solution due to the slow economy. But when the Fed starts to talk about a sustainable recovery, the markets start to panic. Despite the fact that a economy that is recovering is good. A lot of people noticed this and they are very interested in how the Fed will be able to get out of QE.

Although the quantitative easing undertaken by the Federal Reserve in the US gets much more publicity, the UK is testing QE on a larger scale than the US. Japan was the first country to try quantitative easing back in 2001 but that was a limited round of QE. Towards the end of 2012, a much larger dose of QE was being planned as part of Abenomics. In April 2013, the Bank of Japan announced a $1400 billion QE programme. This is supposed to double the money supply.

The European Central Bank, ECB, has its own way of printing money without referring to it as quantitative easing or money printing. The ECB lends money to troubled banks at 1% interest for three years. Most of the money has been going to banks in Italy, Spain, Greece and Ireland. Much of the money is then used by the banks to buy government debt in these countries. This means that the banks make easy profits at the same time as the borrowing costs for the governments have gone down. This program adds an estimated 1000 billion euros to the money supply.

But money printing is also used by countries that have trade surpluses and a pegged currency. China has become the prime example of this but several other countries are using the same strategy, albeit on a smaller scale.

China’s huge trade surplus means that Chinese companies have a lot of dollars which they in most cases want to convert to Chinese yuan. If such huge amounts of dollars were converted into yuan on the open market, the value of the yuan would go up. To prevent the yuan from appreciating, the Chinese central bank, People’s Bank of China, buys the dollars at a fixed price. This prevents the yuan from increasing in value which would make Chinese products more expensive abroad. But from where does the Chinese central bank get such huge amounts of yuan? Easy, it creates the money out of thin air, printing as much paper money as it needs. Nowadays, China not only has a huge trade surplus, China also has a financial account surplus. This means that even more money printing is needed to prevent the yuan from appreciating.

Quantitative Easing for Beginners

Quantitative Easing, or QE as it also has become known as, has become a popular theme in media. But what is really quantitative easing? Will it make things better or worse? Is QE something you should worry about? Here is an article about quantitative easing for beginners, explaining basics.

Lately, quantitative easing has become popular. It simply means that the central bank buys assets with money it has created out of thin air. In essence, the central bank prints money to buy assets from financial institutions. But in today’s world, the money is typically electronic rather than physical bank notes.

Quantitative easing pumps new money into the economy. Previously, central banks adjusted interest rates to either slow down or speed up the economy. But now many central banks have already cut their interest rates almost down to zero. Cutting the interest rate is not working any more. Therefore some central banks, especially Bank of England and Federal Reserve in the US, are testing QE.

The central banks typically buy government bonds from commercial banks and other financial institutions. This improves the balance sheets of the banks. It also pushes up the price of government bonds, which makes them less attractive as investment. The idea behind this is that banks would be more interested in lending money rather investing them in government bonds. This increased lending would boost the economy.

Note that if the central bank would buy the government bonds directly from the government, it would be financing the government debt by printing money. This quickly leads to very high inflation since the central bank is expanding money base. By buying the government bonds from financial institutions, the central banks are technically not monetizing the debt. Many central banks are not allowed to buy government bonds directly from the government.

The Federal Reserve in US also buys mortgage-backed securities in huge quantities. Other assets, or rather debts, are also purchased by the central banks but mostly in much smaller volumes than government securities.

Does quantitative easing work? While the central banks are confident that QE is working, most economists point out that nobody knows what will happen. Quantitative easing has not been tested before so it is simple an experiment on a huge scale. It is quite possible that QE will work but it is also possible that it will not generate any significant results. Even worse, some people are worried that QE may work too well and create hyperinflation. It is worth noting that some experts are worried that the central banks will not be able to stop quantitative easing. They believe that if QE would be terminated, assets prices would fall and a long depression would follow. In essence, if this scenario is true, QE can’t be controlled any longer, the central banks have lost control.

It is still too early to judge how well QE works. In the UK, officials have hinted that QE and low interest rates have not produced the desired results but without QE the situation would be much worse. Most mainstream economists say similar things. QE may not be the perfect solution but without quantitative easing, the situation would be much worse. Like so much else in economics, it is impossible to verify if this is true or not. We simply don’t know how things would have looked like without QE. But a lot of people have noticed that banks have not significantly increased their lending, which was originally the main purpose of QE.

Who are the winners and losers of quantitative easing? The most obvious winners are the banks and other financial institutes, their balance sheets get a healthy boost. Strictly speaking, this is the only proven advantage of QE so far. The risk of banks collapsing has been significantly reduced. Since QE inflates asset prices, assets holders are also winners. The combination of QE and low interest rates makes it very attractive to borrow money to buy assets. Unfortunately, QE also produce losers, at least in relative terms. Savers and people living on fixed income, which include many pensioners, are suffering from higher inflation without getting any compensation. Some people even say that anyone being financially responsible is being punished by QE.

If it is difficult to judge how efficient QE has been so far, it is impossible to know what will happen in the future. The central banks are, officially, very confident that they will be able to withdraw any excess money once the economies start show a healthy growth. Otherwise the excess money would produce inflation. Not everyone is confident that the central banks will be able control the money supply. But as mentioned earlier, a bigger concern is if the central banks actually are still in control. Quantitative easing may have got out of control and can’t be stopped, without crashing the economy.