The equity markets continue to flirt with record highs while the yields on fixed income instruments are at or near all-time historic lows. Generally, those two market movements are not compatible. Everyone feels a high level of anxiety about the economic future. Ben Bernanke visited the Bank of Japan in early July to help them set up a new experimental monetary policy dubbed “helicopter money.” And we are living in an era where most of European and Japanese government debt have negative yields. From an investor’s point of view, negative yields are irrational and should not exist – but they do. Some say that such negative yields are coming to the U.S. In what follows, I will discuss the backdrop to all of this, and outline the straight and narrow path back to economic rationality.
“Helicopter Money” defined
The term “helicopter money” was first used by Milton Friedman in 1969 as a straw man illustration of the inflationary effects of an out of control money creation policy by a nation’s central bank. In 2002, Ben Bernanke, then a member of the Fed’s Board of Governors, used the term in a speech about how central banks could combat deflation. That is how he got the name “Helicopter Ben.”
Friedman didn’t seriously consider “helicopter money” as a plausible monetary tool. But, Bernanke does. It looks like it is about to be launched in Japan. “Helicopter money” is the dollar for dollar creation of money to finance new government debt. It is another form of Quantitative Easing (QE), but more directly financed, and likely at lower than market interest rates. In the U.S., such “helicopter money” is illegal for our Fed, as they are prohibited from directly purchasing debt from the Treasury – so the Fed would have to do it the old fashioned way, by running it through Wall Street.
Policymaker Frustration
The move toward negative interest rates and now “helicopter money” arises out of a frustration among policymakers (especially the monetary authorities) that economic growth has slowed to a crawl in the world’s industrialized nations, and there is a desire to get growth “back to normal.” Nowhere is that “normal” directly defined, but I infer from various contexts that 4% would be such a target. Unfortunately, today’s “normal” isn’t anywhere near 4%. Truth be known, it is likely below 2%. And there really isn’t much monetary policy can do about it. The use of the experimental policies, like negative rates and “helicopter money” carries with it risks, as we can only guess what ultimate distortions such policies will eventually produce.
Unprecedented Change
Since the recession, there have been unprecedented changes in the way people move around, spend money, borrow, get married, buy homes, have children, and the 4% historical economic growth rate is no longer the norm. The potential growth rate of the economy is primarily due to two factors: the growth of the working aged population, and the growth in productivity of that labor force. Currently, the working aged population is growing at a rate of 0.6% per year, while productivity has grown at a rate of 1.3% since mid-’09. Of late, productivity has been falling, showing up as negative in 4 of the last 6 quarters, and that is quite concerning. But, for the sake of argument, let’s use the 1.3% rate noted above. If that is the case, the potential non-inflationary growth rate of the economy is 1.9%!
A combination of demographic trends, technology, and financial issues have converged to produce a slow growth world. I briefly list them below:
- Aging Populations: Retirees spend less than they did pre-retirement. They are now living longer, and with interest rates near zero, have even more incentive to save. Economists have commented on the seemingly out of character rise in the savings rate in non-recession times, but it is clear, at least to me, that demographics and zero rates have a lot to do with it. So, aging populations in Japan, Europe, and the U.S. are a key driver of the slow growth that policymakers see as plaguing the world’s economic scene;
- The Shared Economy: Due to technology, there is an increased use of existing assets and infrastructure, and, thus, less need for additional acquisition. Uber, for example, is only 7 years old. In its first 3 years of existence, it acquired 50% of the San Francisco taxi market. At today’s valuation, it is worth more than Ford or GM. Yet, it owns no cars. Airbnb is the largest hotelier in the world – it owns no properties! The use of the shared economy is much more intense among the younger generations, so we can assume slower than that “normal” growth rate from this crowd going forward;
- Debt & Net Worth: Just like the Great Depression changed the views of its participants toward debt, so, too, did the Great Recession. The home is no longer the ATM it was pre-recession. And, the recession hammered state and local budgets to such an extent that most states were forced to slash their funding for higher education. Over the past 10 years, tuition has risen at a 5.5% annual rate at 4 year institutions while incomes have stagnated. As a result, in 2014, over 70% of graduates had debt. This has contributed to the observed postponement of marriage, child rearing, and first time home purchases by the millennial generation.
Productivity Issues
I mentioned productivity as a key element in the growth equation. We should be quite concerned about the deterioration we have seen in the recent data. For the 6 decades, ending in ’09, real GDP growth per employed person averaged 5.9%. (The data by decade go from a low of 3.3% in the ‘70s to a high of 8.3% in the 50s.) Since 2010, that growth has been a mere 2.0% – and, as I mentioned above, it has been negative in 4 of the last 6 quarters. Much of this is due to a lack of infrastructure spending over the last decade.
The Straight and Narrow
In such a slow growth economy, recession can easily occur simply by an extraneous event. 9/11/01 was a huge event that caused a U.S. and worldwide recession. Today, we expect “Brexit” to cause a recession in the U.K., and the repeated terrorist attacks in France to possibly cause recession there. It concerns me that policymakers continue to rely so heavily on experimental monetary policies with unknown and possibly large negative unintended consequences while ignoring what has worked so well in the past – the use of pro-cyclical fiscal policy.
In the U.S., the nation’s infrastructure continues to crumble; our major cities face crushing gridlock on a daily workday basis. The U.S. is the most powerful economic nation in the world, yet its infrastructure is among the poorest in the industrialized world. No level of negative interest rates or unconventional monetary policy (be it QE or “helicopter money”) can fix this. Enlightened fiscal policy consists of government sponsored infrastructure projects which are built by the private sector and create jobs and income with multiplier effects. Productivity would rise (heck, it would rise if we just cut a few minutes off the daily work commute!) and so would the economy’s growth rate making it more immune to recession from random external shocks.
Recognition is the first step. As long as we look to gimmicks such as “helicopter money,” QE, or negative interest rates, and rely solely on what is clearly ineffective monetary policy, we will be stuck in a slow to no growth mode with higher than normal risk of recession. And we risk as yet unknown unintended consequences.