“What would happen if a helicopter dropped bags full of money into a small town?” Nobel Memorial Prize winner, Milton Freidman, proposed this question as a thought experiment on monetary theory. He is known for his theory on money supply during inflationary periods and as such was awarded the Nobel memorial prize in economic science for his thoughts.(2) Today news headlines are filled with inflationary warnings, talks about wage increases, price increases, labor shortages, stimulus checks, market fears, will it crash? When it comes to news stories or hi-stories I prefer the later. Friedman’s “Helicopter Miracle” can be a useful parable if you are caught in the news storms.
Before we can begin thinking about Friedman’s answer, we need to look at how he viewed money. Friedman believed that the nominal value of money could be described on a supply and demand chart, just like you’d see in an intro economics class.
As the supply of Money goes up, the purchasing power of one unit of money is reduced. However, when the demand for money increases, the purchasing power also increases. The point where money supply crosses money demand is where the nominal value of money matches the real value of money.
This is ideal for money suppliers because it means that there is greater security and confidence in the value of our greenbacks. BUT in the real world, demand for money constantly changes and suppliers aren't always able to calculate or anticipate the demands of world markets. This is why Friedman writes, “No important or interesting issues on monetary theory arise in the hypothetical situation of constant demand and supply.”(1) If there wasn't variation then there'd be no need for central banks.
Freidman also goes on to say that increases in monetary supply only change the price tags of goods sold, and eventually reach an equilibrium in wages. For instance, if money supply doubles, prices of goods follow suit and eventually wages should equally rise. However, Friedman looks to the demand for money in determining the purchasing power of goods. He proposes if a helicopter dropped a bag of money on a town and everyone received an amount equal to their current savings, they must make a decision on what to do with it.(1) Friedman asks what would the outcome be if everyone saved their helicopter money or spent it? He goes on to say if people save this money, the prices of goods would remain the same, there would be no change in purchasing power and everyone would maintain a large savings for various uses. However, if people believe that they have more money to spend on consumption, prices of goods will rapidly climb and fall as the overall economy adjusts to the injection of money. Freidman even goes on to speculate that producers of some goods may take a vacation causing transitory shortages even in the midst of increased demand.(1) As demand for certain goods increased and supplies decreased, prices would aggressively rise. After the initial increase, there would be a demand vacuum as excess savings dried up and production returned to normal causing rapid drops in prices.
If you are following Friedman’s thoughts, you might already start thinking introspectively. Should I buy that car now, or should I wait, I know cars prices are higher will they come down? Or should I buy a house now or should I wait? The questions may be endless, but the charts tell a story. Lumber, gas, coffee, used cars, real estate, and dozens of other prices have gone up and down with unusual volatility. The global pandemic has triggered supply shortages matched with increased spending, labor shortages matched by economic stimulus, security price crashes matched with quantitative easing, and the big question at the end of the day what is going to happen?
Freidman does not leave us hanging, and writes;
Our simple hypothetical helicopter example brings out... (what) some might call a paradox – that is of the utmost importance in the actual course of events… (individually) the money from the sky seems like a bonanza, a true windfall gain.
Yet when the community has adjusted to it, everyone is worse off in two respects: 1. the representative individual is poorer because he now has a reserve for emergencies (with lower real value) 2. he has a lower real income because productive resources have been substituted for cash balances, raising the price consumption services relative to the price of productive services.
According to Milton Freidman we will experience both transitory product price inflation as prices overshoot and undershoot the new baseline level of inflation as well as higher overall inflation. Once markets stabilize, wages will be less able to afford products/services and emergency savings will afford less emergency spending. In the graph below Friedman explains three different ways general price indexes can respond to a 10% increase in money supply. A,B,C all reflecting different responses a market may have to money supply increases, with the flat line showing the new inflation baseline.
When we apply this graph to our world today. We have seen commodity prices, stocks, bonds, housing, used cars, technology, all follow a similar path to lines B and C. Lumber
prices went from $600 in September of 2020 to $1670 by May 2021 and then decline to
the price of $450 by Mid-August 2021.(3) The Car Guru used car price index has gone from $22,000 avg. in January 2020 to $28,000 in September 2021.(4) Home prices have risen more than three times faster over the period from Q2 2020 to Q2 2021 than any other period in the last 10 years.(5)
The Fed reserve expects transitory inflation,(6) but the end impact on the economy would be much more concrete according to Friedman. The question remains what can I do about this?
Your first step might be going over your financial plan with varying inflation rates. If you have an advisor ask them what might be some good best case/worst case numbers. Secondly you may find that you will need to work longer in order to save, budget more tightly or accept more investment risk to achieve your financial goals. A licensed financial professional will be able to walk through all of these areas with you. Lastly Friedman offers some indirect insight regarding how to prepare for an event such as helicopter money, “productive resources have been substituted for cash balances, raising the price consumption services relative to the price of productive services.” Friedman points out that the higher consumption of goods drives up the cost of goods and reduces available cash balances. Experienced investment professionals can help identify financial products that offer inflation protection and may be able to identify investments that take advantage of the rising costs to produce goods.
Blacor Investments has provided Private Investment Advice since 1959, we offer investors investment advice and financial strategies that stem from three generations of investment professionals.
Sources: 1. Money Mischief by Milton Friedman 2. How Milton Friedman Changed Economics, Policy and Markets - WSJ 3. Lumber Price: Latest Futures Prices, Charts & Market News | Nasdaq 4. Used Car Price Trends - CarGurus 5. FHFA Quarterly HPI 6. The Fed's use of 'transitory' to describe inflation may be 'transitory' - CNN
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