by Chris Arnade
An amorphous group of well-connected bankers and economists — and the politicians they support — run global economic policy. On Wall Street, its members are called Smart Money, and they usually come in the form of a hedge fund manager who lives Manhattan or London. They wear clothes bought in SoHo in NYC, or Chelsea in London (Never SoHo in London or Chelsea in Manhattan), and they have slicked back hair, snazzy glasses, Ivy League credentials, and global think-tank connections.
Their view on the seventies is rather dim. Bankers never like inflation, since it withers away the value of the money they lend, and the seventies was further proof how destructive it could be; New York and London were in disarray, rife with crime and run by governments spending too much on silly things like welfare. It was before the dual-headed deity of banking, Margaret Reagan, rose from the ashes to set things right and deliver an edict: Kill inflation and government spending (well, not the defense part). For the last forty years that paradigm has ruled, and Smart Money has supported economic policies steeped in moralistic platitudes about sound money and mathematical proofs about the value of austerity. The result was a financial boom that was good for the markets and very good for their wealth.
Now, inflation is dead and growth is close to nonexistent; Japan hasn’t had much of either for over twenty years, the U.S. and Europe for close to ten. It has left Smart Money stuck, desperately trying to get the world growing again. Since they don’t like government spending, that means finding a way to get people to spend, or markets to climb. In the past, that meant interest rates cuts, which made it easier to borrow to buy homes and cars. But rates are at essentially zero and — despite having sent markets higher — nobody is spending. In Europe rates have even gone below zero, making borrowing costs negative: You have to pay to put your money in a bank account. Gone are the days of getting a free toaster or iPod when you open an account. Now, you have to give the bank a toaster or an iPod.
The U.S. is in slightly better shape. After nearly six years of zero interest rates, the Federal Reserve raised rates earlier this month to just a quarter of a percent above zero. It could easily be a short-term thing. Inflation is still very low, and growth is low, fragile, and at risk of a shock — like a terrorist attack, or another recession (which usually comes every three years or so.) If that should happen, the Smart Money in the U.S. will suggest we follow Europe’s lead and cut rates to negative, pushing markets — and their wealth — higher, but hurting most everyone else.
Or maybe, hopefully, they will support something less disruptive, more effective, and more egalitarian: Just print money — literally print it, not borrow it — and give it to everyone. It is an idea that some economists have suggested for a long time, including one named Ben Bernanke.
When I joined Wall Street as a bond trader at Salomon Brothers in 1993, the Smart Money’s ranks were swelling, riding a wave of deregulation and globalization. Gone were the smaller and quieter private partnerships that had dominated investment banking since the thirties, replaced by sprawling global public companies selling complex financial products. Margaret Reagan was also gone, but there was a new dual-headed acolyte in Bill Blair.
My first boss was classic Smart Money, a well dressed managing director who worked tirelessly, had a genius for making money, and was always concerned that his wealth was about to disappear. “Do you see what is happening in Brazil? A thousand percent inflation and the government seizing bank accounts.” Our office was in the World Trade Center, and whenever we went to a business meeting in midtown, he would wave down a black cab. If I suggested the subway was quicker, he would scoff, “Too dangerous, it is filled with tuberculosis.”
The Smart Money world view dominated, but cracks were starting to appear. Japan was on the backside of a mother of all financial bubbles, which had imploded spectacularly in 1991, and it was stuck in a depression it was unable to escape. Japan cut rates, as prescribed, but growth wasn’t coming. With its rates at zero, they started spending more and more, hoping to get anything going. The Smart Money smelled blood, sensing an opportunity to exploit what it saw as a massive mistake, convinced that the spending would lead to inflation, or worse, a complete implosion of the economy from too much debt. After repeated trips to Tokyo, countless dinners with their cohorts in universities, think tanks, and governments, Smart Money re-focused its trading books to bet that Japan would implode in a future crisis they had already labeled the “Sakiiiii bomb.”
It didn’t happen. The bet became known as the “widowmaker,” leaving the Smart Money with a lot of losses, and bad memories. It also was responsible for one of my favorite trading floor exchanges:
Trader 1: “What is the smart money doing in Japan?”
Trader 2: “I don’t know what the smart money is doing, but the dumb money is running them over.”
For the next twenty years, Japan spent its way to debt three times bigger than it was in the nineties. It never experienced mega-inflation; it didn’t grow much either.
Around that time, the chair of the Princeton Economic Department, Ben Bernanke, who had studied and written extensively about the Great Depression, was also thinking about Japan, which was following the conventional path of having its central bank cut interest rates to get people to spend. The problem, he thought, wasn’t too much inflation and too much government spending, but the opposite: too little inflation and too little spending. In a December, 1999, he gave a talk outlining how Japan should deal with its low growth and low inflation:
An alternative strategy, which does not rely at all on trade diversion, is money-financed transfers to domestic households — the real-life equivalent of that hoary thought experiment, the “helicopter drop” of newly printed money. ….. Then the real wealth of the population would grow without bound, as they are flooded with gifts of money from the government. Surely at some point the public would attempt to convert its increased real wealth into goods and services, spending.
This idea was both simple and old: Japan was not growing because people were not spending, no matter how low interest rates were, so the central bank should just print money, without borrowing it, and give it to everyone (the “helicopter drop”). Then keep printing money and keep giving it to people until they started spending, and the economy — and inflation — should start to grow again. This idea had been proposed long ago, by nerdy economists doodling around with the very problem Japan faced, something they called a “Liquidity Trap.” It was an idea that didn’t just break the Smart Money edicts, but did so spectacularly. It was uber spending, an indiscriminate dispersion of wealth that gave money to everyone (even the poor!), didn’t increase debt, and was sure to cause inflation. The Smart Money laughed at Bernanke, and whenever he appeared on business shows, his face on the TVs of the trading floors, whoops of “Helicopter Ben!” would rise above his words.
“Helicopter Ben” was serious though, and besides being a great economist he was a good politician, so he downplayed his edict-breaking musings and kept climbing the policy ladder. After a period as a member of the U.S. Federal Reserve, in 2006, “Helicopter Ben” became its chairman.
Two years later, an economic crisis consumed the U.S. as the financial system that the Smart Money had constructed came undone; markets collapsed, and many banks went underwater. The policy that Bernanke unleashed to deal with it was two-pronged: The Fed, which Bernanke ran, printed money, while the U.S. government bailed out the banks and the financial system, under TARP. The government, now partly controlled by Obama, also gave out borrowed money to the “plebes” via the “American Recovery and Investment Act of 09,” pushing up the government debt, and angering the Smart Money. Meanwhile, Bernanke’s Federal Reserve, unable to cut rates any lower, did begin to print money under a complex program called Quantitative Easing. The money wasn’t given out, but used to buy a lot of government bonds, in an attempt to bring the longer term cost of borrowing down and to encourage spending (print money, spend it on bonds, cash from bonds is put in bank, bank lends out cash).
QE split the Smart Money. Some saw it as breaking the edict to kill inflation. (Their view is any printing of money, regardless what you do with it, debases its value, causing inflation. Or in their words, “If you just open the fucking taps, the fucking bathtub will flood.”) But those complaints generally fell on deaf ears, since QE had also stabilized the markets, their jobs, and their wealth. The cash used to buy bonds ended up sitting in the banks, who hoarded it. Which, to some, made QE pointless, and to others, wasn’t that surprising of an outcome. (It’s like a billionaire going out and saying, “Hey, I am going to buy nothing but hot dogs,” and then being surprised when hot dog vendors end up with lots and lots of cash.)
So, if the government was willing to hand out cash, and the Fed was willing to print money, why didn’t it do a helicopter drop? The Fed doesn’t have a clear mandate to give out cash to citizens, which is considered fiscal policy, and that is the job of the elected government, not appointed officials. Yet it’s not a problem that couldn’t be overcome with an aggressive interpretation of the Fed’s role, some clever accounting schemes, and politicians willing to support it. (There is little hope of getting politicians to support it, though. Neither of the current political parties are crazy about cash handouts, albeit for different reasons. The Republicans hate the idea of expanding the role of the Fed or the government, especially when it is to give a certain class of people something for nothing — even if giving out printed cash is really just another form of a tax cut. Democrats, on the other hand, would rather give out targeted cash through complex programs to encourage this or discourage that.)
Roughly thirty-four years after the ascendency of the Smart Money, a period that has seen it acquire vast wealth and power while the rest of the U.S. has stagnated, much of the world faces low growth, zero rates, and little inflation. The Smart Money has started to come to grips that this might not end anytime soon, a possibility they have taken seriously enough to give it a name: secular stagnation.
Four years ago, I quit finance, sick of the whole game. A few months later, after Obama’s re-election, I went out with a group of traders, including my old boss. We ate steaks, drank a lot, and told stories of trades that worked, and trades that didn’t. Many of the traders were drinking away a bad year they had spent betting that the U.S. would blow up, and that inflation would spike. Like Japan, it hadn’t. After dinner, my old boss offered to split his black cab with me. I declined, saying the subway would be faster. He looked at me and smiled, although it wasn’t clear he was joking. “You should wear a mask,” he said. “With that man in power, it is only a matter of time before this country is filled with inflation, crime, and the subways with tuberculosis.”