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Financial red lights are flashing again: helicopter money has to be in the tool kit

January 22, 2018

“There are so many lights flashing red, I’m losing count” – Neil Woodford, the UK’s most high-profile fund manager, is quoted in a range of media outlets.

Niall Ferguson who predicted the 2008 crash also warned in November’s Times, “Look up: financial red lights are flashing again!”

In the FT Woodford says, “Whether it’s bitcoin going through $10,000, European junk bonds yielding less than US Treasuries, historic low levels of volatility or triple-leveraged exchange traded funds attracting gigantic inflows — there are so many lights flashing red that I am losing count.” Jason Cummins, chief US economist at Brevan Howard (offshore based hedge fund management company) agrees in another FT article, “several metrics of market valuation are indeed flashing red”.

  • Equities have added to last year’s 20 per cent gains and already broken records.
  • New risks to financial stability, such as the recent interest in bitcoin, are reminiscent of the kind of investor mania that often precedes a financial crisis.
  • The cyclically adjusted price/earnings ratio currently exceeds the peak seen on the eve of the stock market crash of 1929 and is approaching the all-time high seen during the tech bubble in 2000.
  • Credit valuations are high despite a flood of issuance.
  • High-yield and investment-grade volumes reached record levels in 2017

He reminds readers that the two most recent recessions were caused by financial market excesses rather than macroeconomic ones, adding that “it seems politically naive to fight a stock market crash by trying to bail out Wall Street again” at a time when the US is politically divided. Then says, “it is worth asking what role monetary policy should play”.

Economist Desmond Lachman, a Fellow of the American Enterprise Institute  for Public Policy Research, a Washington think tank, answers:

“Jason Cummins does us all a service by noting that various financial market indicators are flashing red about financial stability risk. However one has to ask whether it is not too late for the Fed to do anything now by issuing warnings or by raising interest rates to avoid excessive market risk taking.” He continues that there is ‘scope for monetary and fiscal policy to address the fallout from the bursting of financial asset market bubbles’.

“Though there is no political appetite for yet another round of quantitative easing, there would seem to be nothing to stop the US from the US from resorting to some form of Milton Friedman-style “helicopter money” that would involve the US Treasury sending each citizen a cheque that would be financed by the Federal Reserve on the easiest of terms.

“One would think that helicopter money would be effective in providing the economy with needed stimulus in the event of a large asset price correction. It would also be politically very popular in that, unlike quantitative easing, it would not be seen as a policy that favoured Wall Street over Main Street”.

Endnote by Martin Wolf

Why should state-created currency be predominantly employed to back the money created by banks as a byproduct of often irresponsible lending?    . . . the view that it is never right to respond to a financial crisis with monetary financing of a consciously expanded fiscal deficit – helicopter money, in brief – is wrong. It simply has to be in the tool kit.

 

 

 

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