Opinion: Financial world agog as 'Helicopter Ben' gets ready to stimulate again

By Bernard Hickey

The financial world has been on tenterhooks wondering what the US Federal Reserve was about to unleash on financial markets and the global economy.

(Updated with details from the US Federal Reserve statement announcing a more limited stimulus, including the reinvestment of bond principal payments back in US Treasuries, rather than a larger stimulus that some had hoped)

The US economy's very slow recovery and its dip back towards deflation and a Japanese-style stagnation triggered a new round of speculation that the US Federal Reserve was planning yet more monetary stimulus.

The US Federal Reserve's Open Market Committee issued the statement around 6.15 am New Zealand time on Wednesday detailing how it will try to get the US economy going again.

Many in financial markets expected a second round of money printing known as QE II or Quantitative Easing II. Instead they got QE II Lite, with the Federal Reserve essentially recycling existing stimulus rather than withdrawing it.

Federal Reserve Chairman Ben Bernanke described in a 2002 speech how he would fend off deflation by tipping piles of cash out the door of a helicopter as he flew over the economy.

Some expected him to announce something similar.

Two questions remain. How could the money be distributed into the economy and would it create hyperinflation?

Most believed the creation of reserves for the banks to lend out to private individuals and companies would be ineffective because borrowers and banks are either too indebted or too starved of capital to lend it out and borrow it.

Another option was for the US Federal Reserve to buy more mortgage bonds and US Treasuries in the open market to force down interest rates. The trouble is that interest rates are already very low and it's not making much difference. In the end, the Fed decided to use the principal repayments on mortgage debt it had already bought to purchase more US Treasuries. This is not the 'shock and awe' campaign of money printing some had hoped for.

The final option was for the US Federal Reserve to essentially monetise US government deficit spending by promising to buy new US Treasuries with the money it is printing. Instead it decided to monetise the deficit using money already in existence. Here's the key paragraph.

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.1 The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.  

The risk here is that global financial markets lose confidence in the ability of the US government to keep servicing its debt, given that more than half of US Treasuries are owned by foreigners, unlike in Japan where its government debt is held by domestic savers.

The next few days could prove decisive in the current debate between those warning of deflation and those warning of eventual hyperinflation.

We could be entering a Japanese-style era of deleveraging and balance sheet recession that causes long term deflation and low growth in developed countries.

Or we could be entering a period of inflation and hyperinflation driven by reckless and competitive money printing by central banks.

Or maybe something in between.

A weak or devaluing US dollar could push the New Zealand dollar higher and hurt our export-led recovery. A collapse in confidence in the US dollar would cause severe ructions on global financial markets and further restrict access to foreign funding for our banks. A new round of turmoil on global markets would push up long term interest rates.

Whatever happens, the announcement from the US Federal Reserve will be crucial.

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