Wednesday, May 1, 2013

Helicopter Money - Doing the Drop on Currency

Would you like to own a 100 trillion dollar bill at a cost of 1.5 U.S. dollars? However, the dollar bill is not issued by the central bank of a world reserve currency but by the Reserve Bank of Zimbabwe. When the government of Zimbabwe overspent on wars and employees’ salaries and swindled public money’s through corruption in the 2000s, the government decided to finance the deficit spending by printing new Zimbabwean dollars with expiration dates on the bills. The money velocity skyrocketed, leading to hyperinflation of more than 500 billion percent in 2008 and a complete loss in confidence of the currency’s future value. The helicopter money experience ended horribly as the Zimbabwean government abandoned its own currency and now uses foreign currencies with mostly the U.S. dollars.

What is helicopter money?
Helicopter money is a term used by the Monetarist economist Milton Friedman who advocated that price deflation can be saved by money falling out of a helicopter. It means that the government, not the central bank, sends free cash or cheques to its taxpayers in the hope that the inflation and money supply will rise, and the receivers will simply spend the money to increase the aggregate demand. Helicopter money is called for when the economy suffers a great contraction and deflation and is in a liquidity trap where monetary policy becomes impotent. Helicopter money is a fiscal policy and not a monetary policy tool. If there is a concern that funding the helicopter money spending through bond issuance will jack up interest rates, then the central bank can fund the deficits by holding the bonds in its own balance sheet and crediting the government’s account.

How is helicopter money different from quantitative easing?
Currently, quantitative easing (QE) has been widely used for monetary stimulus by global central banks. QE is the creation of money by the central banks to buy government bonds by creating excessive bank reserves in the banking system. However QE, unlike helicopter money, does not go directly to the pockets of the consumers and households but to the banking system that the central bank buys bonds from. If the banks decide not to lend out these excess reserves due to the fear of defaults and other reasons, the aggregate demand will not increase and the private economy remains stuck. QE is reversible while helicopter money is not. In the words of Financial Times’ Martin Wolf, helicopter money combines fiscal stimulus with monetary expansion.

Helicopter money and currency trend
Given the goal of the helicopter money is to resurrect deflation and drive up inflation, an economic consequence will be currency deprecation as inflation rises. If the helicopter is unloading too much money too quickly, hyperinflation will result, leading to massive damages in the economy and currency devaluations. To help its exports grow faster, every economy in the world currently would like to see its currency weaken. Therefore one country’s monetary easing policy leads to a competitive response by another country with the result of competitive devaluations. As one currency depreciates, another is forced to rise - the Japanese Yen during the 2008 financial crisis and the Euro/Dollar earlier this year, which will hinder the economic recovery.

Navigating using an online system
Helicopter money and quantitative easing are some of the macro themes that can have a tremendous impact on currency trends and developments and therefore your bottom line in currency trading. Forex traders should do enough homework to understand the macroeconomic policies and politics that influence the currency directions both in the short-term and the long-run. Using forex online trading that comes with free market insights, educational tools, a free demo account and charting resources is the best way for you to gain valuable knowledge of the forex market before dipping into the currency pairs with real capital.