Fearing crash, bond fund Pimco warns off 'helicopter money'

LONDON (Reuters) - One of the world’s biggest bond fund managers has urged central banks not to dole out free cash to citizens saying it could lead to hyperinflation, a debt market sell-off and even a banking crash.

The offices of Pacific Investment Management Co (PIMCO) (L) are shown in Newport Beach, California August 4, 2015. REUTERS/Mike Blake

Such schemes, in which central banks effectively finance government budgets, have been likened to helicopter drops of money. The idea has been around for a while but has re-entered policy-speak as many central banks struggle to stoke growth and inflation via other means.

But PIMCO says its research shows that since the late 18th century there have been 56 examples of similar schemes, from France in 1795 to Zimbabwe in 2007, and all have had severe consequences.

“This is a place you don’t want to go to,” said Andrew Bosomworth, head of portfolio management in Germany at PIMCO, which manages $1.43 trillion of assets.

“If we look back in the past, it shows that when central banks tried just a little bit of this, it created huge amounts of inflation.”

The term “helicopter money”, coined by American economist Milton Friedman in 1969 and cited by the former chairman of the U.S. Federal Reserve Ben Bernanke in 2002 as a scheme that could fight deflation, has recently regained attention.

The chief economist of the European Central Bank -- which is already spending trillions of euros via the banking system to try to stoke near-zero inflation -- said last week that such a policy could, theoretically, be considered.

How such a scheme would work in practice is unclear but PIMCO’s Bosomworth said that under any guise it would likely lead to an uncontrollable spike in inflation expectations that would blindside financial markets and send bond prices tumbling.

European investors, who have reaped huge rewards as bond prices have risen with the ECB buying debt under its quantitative easing scheme, experienced a painful sell-off last year.

In April 2015 a small uptick in inflation prompted a sharp surge in German 10-year government yields that caused double digit losses for many holders in a matter of weeks.

Bosomworth said helicopter money would mark “a clear move into a whole new phase of monetary policy, where there is a huge amount of uncertainty”.

He added that if a bond rout were to occur on a bigger scale, banks in many euro zone countries would come under pressure as they hold the bulk of the government’s debt for regulatory reasons.

Their pain would not stop there.

“Banks get stuffed because they have fixed-rate mortgages and loans to companies that represent a very high opportunity cost to them because we enter a new regime where interest rates are a lot higher.”

The one unknown, said Bosomworth, is that none of the historical examples show what might happen if helicopter money were introduced against a backdrop of low inflation or deflation, as is the case in Japan and the euro zone.

“Maybe they try it and this time it is different... but there is no evidence that they have ever been able to give the right dosage of helicopter money to get the desired outcome.”

Editing by Nigel Stephenson