Industry Insider: negative rates and 'helicopter money' are hot topics now
So other 'unconventional' methods of kick-starting the global economy are being tried and tested.
Negative rates and 'helicopter money' are now the hot topic at many central bankers’ dinner parties (thank goodness we're not invited). These phrases are being bandied about without any thought as to whether they mean anything to the likes of you and me.
Quite simply, negative rates and helicopter money are designed to have the same outcome: to make people spend money.
During deflationary periods when the costs of 'things' go down instead of up, people and companies hoard money instead of spending it. Why pay £100 for something today when it will cost £95 next month? Lower demand for goods and services leads to further price cuts and businesses going bust. It's a downward spiral and one that central bankers want to avoid at all costs.
Throwing good money after bad
Before everyone panics and I cause a rush on the banks, negative interest rates are not being used in the UK right now, and I don't believe they will be hitting a high street near you anytime soon. However, they are being used elsewhere in the world, so it's helpful to understand them.
In theory, negative rates mean that instead of paying someone interest to hold their savings the bank is charging them to look after their cash. So the value of their savings is diminishing in both nominal and real terms. The logic runs that instead of saving the money, people will spend it before it loses any more value. It's either that or you start putting money under the mattress.
In reality, this hasn't really happened in any of the countries where negative interest rates are being used. It's actually the banks that are paying the price right now. They are being penalised to hold money themselves in the hope that it will lead them to lend money more freely to both companies and individuals. In the meantime, the banks' profits are under pressure.
Helicopter money is similar, and it's not a new idea. David Hume, an 18th-century philosopher, asked what would happen if a good fairy went around doubling the money in everybody’s pockets. He concluded that no one would really be richer, because prices would double. In 1969, nobel laureate Milton Friedman replaced the fairy with a helicopter. That's progress for you.
So while money doesn't grow on trees, cash could fall from the sky. The central bank would print money and distribute it to households. It's a windfall to be used to help the economy grow. It may be nice for a shopping spree, but the hyperinflation that could ensue may not be so pleasant. Ask anyone from Zimbabwe.
Unfortunately, neither ploy is likely to work as intended. In Japan, the sale of personal safes to store cash are at record levels and in Switzerland, which has rates deeper in negative territory than anyone else, you can't rent a safety deposit box for love or indeed money.
The central banks are slowly losing the plot. The Bank of Japan admitted last month that despite massive dollops of quantitative easing, plus negative rates, deflation is still endemic, making it even less likely for Mrs Watanabe to spend.
We live in interesting times. I'm not sure what's going on and I'm not convinced the world's central bankers do either. The markets were expecting more of the medicine that hasn't worked in Japan for the past 25 years but when it didn't happen, the QE-addicted risk junkies wiped off 1000 points from the Nikkei, and the yen shot up: the polar opposite of what they hoped would happen.
So what to do with an investment portfolio? Having a decent level of diversification seems a sensible place to be right now. Well-diversified funds that we think are worth a look at include Artemis Strategic Assets, F&C MM Navigator Distribution, Jupiter Merlin Balanced and Rathbone Strategic Growth Portfolio.
- Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Mr McDermott's views are his own and do not constitute financial advice.
Darius McDermott is the managing director of Chelsea Financial Services and FundCalibre.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.