Helicopter Money And Gold

Monday, March 28, 2016

yellenThe idea of helicopter money is gaining popularity right now. What is it and how would it affect the gold market?

Some Background

The faith in monetary policy has recently diminished as central banks have not been able to spur global growth and consumer prices. There is growing fear that central banks are out of ammunition since neither quantitative easing nor ZIRP nor even NIRP boost economic recovery. Therefore, some analysts speculate that helicopter money may be the next monetary tool that some central banks use as the threat of deflation looms. Mario Draghi at the March ECB’s press conference said that “it’s very interesting concept”.

What Is Helicopter Money?

The term “helicopter money” stems from a hypothetic scenario envisaged by the Milton Friedman in his essay “The Optimum Quantity of Money” from 1969. In order to abstract from the distributional effects, he assumed banknotes were dumped out of a helicopter in such manner that each individual happened to pick up an amount of money equal to the amount he held before. In such thought experiment, the increase in money supply would lead only to doubling of prices (as a result of people’s attempts to spend their enlarged cash balances). Importantly, Friedman used “helicopter money” only as thought experiment useful in the assessment of the effects of an increase in money supply. However, Ben Bernanke echoed the idea in a different context in 2002 in his famous speech about deflation, following Eggerrtsson’s paper. He argued that money-financed tax cuts “would almost certainly be an effective stimulant to consumption and hence to prices” (by the way, this is how he earned his cute nickname “Helicopter Ben”). Hence, we can define “helicopter money” as money which is printed and then injected straight into the economy via tax cuts or spending programs. The idea is to directly inject new money into the spending stream. The aim of quantitative easing was to bypass banks and inject money via assets markets. Helicopter money goes even further as its aim is to bypass the assets markets and spur spending directly rather than influence bond yields.

Helicopter Money and Gold

It should be clear now that helicopter money may boost inflation. Surely, this is exactly the aim of the central banks, however, there is a risk that things will get out of control. Printing money and spending it directly on goods and services is the simplest way to hyperinflation. The very reason why the quantitative easing did not lead to the drastic rise in inflation is the fact that the central banks were purchasing assets by funds which later remained at commercial banks as reserves. The idea of helicopter money assumes that instead of using money to buy assets, the central bank gives it away to people (or to the government to finance tax cuts or public expenditure, or both). Hence, it assumes that central bank either gives money to people for nothing or directly financing budget deficits. In both variants, we should expect the rise in inflation and thus, the increase in the price of gold. Although the yellow metal is not always the ideal inflationary hedge, helicopter money would raise fears about the rampant inflation and spur a safe-haven demand for gold.

Conclusions

Although helicopter money is not yet high on the agenda of any central bank, the idea is receiving considerably more attention. This is why gold investors should be acquainted with the helicopter money and its possible impact on the gold market. It is difficult to say anything with certainty without the details how would it work, but the idea looks similar to direct monetization of debt and the worst Weimar style of stimulating aggregate demand. If adopted, it would be a sign of central banks’ real desperation in frantic attempts to induce inflation at all costs. Gold should shine then.

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold. However, this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium-term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more). Rest assured we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.

Arkadiusz Sieroń is the author of Sunshine Profits’ monthly Gold Market Overview report, in which he keeps subscribers up-to-date regarding key fundamental developments affecting the gold market and helps them prepare for the major changes. Arkadiusz is a certified Investment Adviser, a long-time precious metals market enthusiast, and a Ph.D. candidate. He is also a Laureate of the 6th International Vernon Smith Prize.  You can reach Arkadiusz at Sunshine Profits’ contact page.