How the financial world views the situation and possible plans.

I recall a conversation with an undergraduate econ major during my graduate days. He explained that he became a Socialist. He outlined how he envisioned (i.e. how his Professor envisioned) the process whereby the State would finance capital formation and investment in the absence of private banks. His answer was "the State would generate the money." I often wondered what happened to this student. He is most likely working for the FED.

OK. So we had QE1, QE2, Twist and QE3. WE also have the most radical Leftist President and a complaisant Congress willing to give him what he wants in the budget. How did this work out? Well, growth is anemic, wages are stagnant, the middle class is hollowed out and the economy is slowing. The FED does not dare to raise interest rates, fearing a slide into recession. But, economists know the real score (even if publicly denying it) and they are thinking of how to get out of the low growth and increasing debt scenario. Here is Jeffrie's David Zevros explaining it:

“But what if these tools are not enough? What if inflation and growth do not respond to the stimulus? What if the debt/GDP ratio cannot be pushed back to a sustainable level that allows the economy to grow? Then I would argue we step into the final phase of the unconventional monetary policy experiment — helicopter money. Milton Friedman first proposed it in 1969, and Ben Bernanke brought it into the modern day discussion in 2003. The idea of course would not be to drop 10,000 Yen notes across the rice fields of Japan. Rather, the idea would be for the central bank to buy up a significant portion of the government debt and simply dispose of it. Central bank debt extinguishment is helicopter money.

“The central bank balance sheet is of course left technically insolvent. And while this may bother some folks optically, there is actually no loss or recapitalization necessary. A central bank can have a negative net worth for decades or frankly forever. There are no shareholder revolts. There is no default. All payments are made, and all creditors are made whole. Of course without a large asset base at the central bank, draining reserves, paying interest on reserves, and conducting traditional monetary policy becomes quite complicated. However, the central bank always controls reserve requirements, so in theory they can still tighten without any assets on the balance sheet.

“The idea of debt disposal via the central bank balance sheet may sound far fetched at first glance, but I can imagine a younger generation that will increasingly warm up to the idea!! In fact, in many ways the central banks have already dropped the money. It’s in the system. We all however look at the debt on the central bank balance sheet as something the private sector must pay back. We look at it through a Ricardian lens — and thus it is a drag on economic activity. If the debt is extinguished, the Ricardian dark clouds that have been holding back the private sector are lifted. And the incentives to consume and invest in the private sector are once again restored.

“As a final thought experiment just imagine that by 2018 the BoJ has a balance sheet that is 2 times GDP (today it’s about 0.8). And suppose it decided to extinguish that debt leaving only a 50% debt to GDP ratio. Remember all holders of JGBs have been paid. There is no default. The central [bank] has simply replaced the debt with currency through QE. What happens to the Nikkei, JGBs and the Yen? And what happens to consumption, investment and inflation? I think it’s a wonderful thought experiment. My guess is the Nikkei rises, JGB yields rise and the Yen weakens. Furthermore, consumption and investment rise along with inflation. The question is only one of central bank stability. Can they control the INCREDIBLE reflationary power of helicopter money? That is the hardest part of the experiment. And to be sure, there is certainly plenty of room for error.”