Helicopter Money

The Conservative Party conference last week was noticeable on a number of levels. Not least because of an overt push from our new Prime Minister to grab the political centre ground. Had we not already seen some astonishing political changes across the globe already this year, we might have been even more shocked by a Tory leader calling for more controls over business and a bigger involvement of the state in almost every aspect of our lives. Parts of the speech that had the party faithful gushing with praise were not that far removed from the manifesto that “Red Ed” Miliband took to the voters a little over a year ago. The Guardian gleefully referred to it as “red Toryism”.

She also hinted at two other deviations from past policy, which are in the process of becoming a new orthodoxy of economic thought. The first is that monetary policy action in the UK and elsewhere is at the limits of what it can achieve, and that an element of fiscal policy support is now required to help boost growth in these uncertain times. The second – and a corollary of the first – is the suggestion that ultra-low interest rates are doing more harm than good in supporting a sustainable economic recovery. In our “Wise Men” strategy meetings, we unanimously agree with the first point. It is time for productive investment in the country’s infrastructure to be significantly increased. We know that there is a structural shortage of housing, and we also know that there are areas of the country that would benefit significantly from an upgrading of their road network.

On the second point, there is a sharp disagreement. Personally, I believe that anything other than very short term business investment is being held back by a lack of confidence in what “real” monetary policy looks like in the future. Equally, I believe that a sharp rise in base rates to (say) 3% would immediately offer more income to savers, and would rectify a substantial part of the pension deficit problem on the collective balance sheets of UK companies. In terms of its effect on borrowing, I don’t believe that anyone borrowing today really does so on the basis that a 0.25% base rate is a sustainable reference point for lending. If borrowing and investment is currently being done that could not be supported at 3% base rate, then it is probably better off that it is not done at all.

The alternative view taken by one of my learned colleagues is that any such rise in short term rates would decimate inflation expectations to the extent that longer bond rates would dive into negative territory, and exacerbate the funding problems of corporate pension funds.

That, as they say, is what makes a market.

Other, hitherto “loony”, policy proposals have also been gaining traction, and there is now a genuine economic debate over the use of “helicopter money” to stimulate growth in the economy. For clarification, helicopter money is generally used to refer to unfunded public spending by governments, who increase the money supply simply by printing the currency without any corresponding borrowing on the other side. It differs from QE by directly being spent and increasing economic activity. The evocative name was coined by renowned economist Milton Friedman, because the impact is deemed to be similar to a helicopter dropping newly minted cash into residential streets for the population to pick up and use. Because of the unexpected nature of the drop, there should be a high chance that the money is spent rather than saved, thereby giving an immediate injection to economic activity.

In theory, there should not be any downside to the policy, beyond perhaps a one-off eventual adjustment to overall prices. The historical risks have been when governments use it persistently to fund spending and hyperinflation eventually ensues.

In the UK, one can argue that we have already been experiencing something close to a helicopter drop of cash over the past five years. Since 2011, over £25bn has been handed back to consumers for mis-sold PPI products over the 1990s and the early 2000s. To the vast majority of recipients, the repayment is likely to have been perceived as a surprise bonus, and therefore spent – perhaps on large, one off “treats” like a new car or bathroom, or an exotic holiday. Adding in the expenditure multiplier effect, then the impact of these refunds on overall economic activity is likely to have been material. More so, because had these payments not been made, the cash would most likely have been used to bolster bank balance sheets, or be passed to shareholders in the form of dividends, and then reinvested in other financial assets. Both of these actions would have had a much smaller impact on economic activity.

ppi

From the banks’ point of view, it has been a long time coming, but there is evidence that this enforced largesse is coming to an end. The Financial Conduct Authority releases monthly figures of the sums paid back to consumers in the form of PPI refunds1. Over the course of this summer there has been a marked decline in the level of payments made. The July 2016 disbursement of £244m was the lowest monthly payment since September 2011 when the process was just swinging into action. Now, summer months are typically quieter in terms of reclaims, but even year on year comparisons show a meaningful reduction in the value of refunds paid out.

None of this is particularly unexpected, and in any event, the FCA has announced a time bar for new PPI mis-selling claims of June 2019 for claims to be submitted. In practice it is likely to have wound down very substantially by then.

If PPI payments continue to trend down, this is likely to add even more pressure to consumer goods companies already battling with issues like weather affected trading patterns, rising labour costs, Brexit uncertainty and the sharp reduction in the value of Sterling relative to import currencies. It is most likely to be felt in large consumer durables like cars and furniture. With Sterling so weak, airlines and overseas travel companies have to be vulnerable.

On the flip side, it marks the beginning of the end of a scandal that has – when costs and current provisions are included – knocked more that £40bn off the retained earnings of the UK banking sector. That is roughly the same size as the UK government’s bail out of Royal Bank of Scotland.

We don’t see any of this as a threat to economic growth in the UK. The reduced pay-outs will be compensated for in aggregate by increased government investment in infrastructure, and domestic leisure companies will benefit from the increase in overseas visitor levels enticed by a much cheaper holiday to London, Edinburgh or Cornwall. But, like the political landscape, the sands will shift to make for a different investing environment.

1 https://www.fca.org.uk/consumers/payment-protection-insurance/monthly-ppi-refunds-and-compensation