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Hillary Clinton has a 65% chance of winning the election; she receives 334 electoral college votes according to our model. Trump still requires an exogenous shock to win. Meanwhile, the USD is poised to rally - and leftward-moving policymakers will applaud its redistributive effects while MNCs suffer the consequences.

Investors are overstating the legal and political constraints to "helicopter money"; The BoJ and BoE have few legal hurdles, whereas the ECB would have to get creative to stay within the existing law; Inflation-phobia in Germany will wane if the choice becomes euro survival; The BoJ has already laid the framework for debt monetization with its Sept. 21 decision; The risk is that debt monetization is a difficult policy to restrain once unleashed; Our long-term bet is bullish on an inflation comeback and Japanese risk assets. The helicopters are coming. The global appetite for outright debt monetization, i.e. "helicopter money," appears small today. However, the research philosophy at BCA's Geopolitical Strategy holds that policymakers respond readily to constraints and rarely get to pursue their preferences. As such, we approach every issue from the perspective of what policymakers have to do, not what they want to do. That is why we perked up when the Bank of Japan announced a new monetary policy framework on Sept. 21. The central bank says it will target the yield curve rather than the monetary base in its quest to increase inflation, reduce real interest rates, spur growth, and catapult Japan out of its long-lived liquidity trap. Assuming the policy evolves, as is typically the case, and comes to be accompanied by more ambitious fiscal spending, as we think will happen, it helps clear the way to debt monetization in all but name.1 Our colleague Peter Berezin, Chief Strategist of BCA's Global Investment Strategy, has shown how policymakers may end up dining at the trough of "money printing" (Charts 1 and 2).2 Chart 1As Long As Credit##br## Expands Faster Than Income ... bca.gps_sr_2016_09_26_c1 bca.gps_sr_2016_09_26_c1 Chart 2... Debt Burdens Will Remain High bca.gps_sr_2016_09_26_c2 bca.gps_sr_2016_09_26_c2 To summarize, Peter argues that: The BoJ and the ECB may find themselves in a situation where they have no choice but to implement heterodox monetary policy, and that may happen relatively soon. Negative interest rate policy (NIRP) has failed to increase inflation and demand, leaving intact the global deflationary tail risk and forcing policymakers and investors to ask, "What next?" Japan is stuck in a liquidity trap. Therefore orthodox monetary policy will not increase inflation and demand. Fiscal policy is needed (Charts 3 and 4). There are high political and economic constraints to raising tax rates in Japan. Hence there is little scope for fiscal stimulus that does not increase indebtedness. In the euro area, a return of the sovereign debt crisis cannot be discounted, once the lagged effects of the massive decline in bond yields and credit spreads, a weaker euro, and lower oil prices dissipate in the future. Helicopter money may become politically appealing as a way in which to boost inflation and demand in order to assuage the political costs of painful structural reforms. Chart 3Japan Is In##br## A Liquidity Trap Japan Is In A Liquidity Trap Japan Is In A Liquidity Trap Chart 4Fiscal Stimulus Will Not Drive Up##br## Interest Rates In A Liquidity Trap Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics We agree - and yet the politics can be tricky. In this analysis, we ask, What are the legal and political hurdles to debt monetization, and what are the political risks of pursuing such a policy? We believe that investors may be overstating the constraints to ultra-unorthodox monetary policy. However, we also share the view of our colleague Martin Barnes that debt monetization would entail significant "mischief," including higher political and geopolitical risks.3 Helicopter Shopping Monetary financing (i.e. "helicopter money") can be implemented in various ways.4 Whatever option is chosen, the chief advantage is that "Ricardian Equivalence" does not apply.5 This means that even as the government issues new debt, households and corporates will not restrict their spending and investing on the expectation that taxes will eventually have to go up. Debt monetization avoids this demand-suppressing phenomenon because central bank money is irredeemable, which leads to a permanent increase in the monetary base and should therefore lead to higher inflation and demand. Helicopter money is fiscal stimulus financed by monetary means (hence the term "monetary financing"). Even handing cash directly to households is ultimately a form of fiscal stimulus, equivalent to a tax cut. Critically, and unlike the latter, helicopter money does not involve any increase in government debt levels. There are several forms of monetary financing worth expanding on: Perpetual QE: The government issues government bonds and sells them to financial market participants in order to increase public expenditures or cut taxes. Beforehand, the central bank assures the public that it will buy the same amount of debt in the open market and will never sell it back again. Since bonds are normally redeemable, Ricardian Equivalence is avoided only if the central bank can credibly commit itself never to sell the purchased bonds to the open market. Then it does not matter whether the central bank cancels these bonds or rolls them over when they mature.6 Haircut on existing debt: Central banks could take a haircut on their existing holdings of government bonds, letting a large part of the public debt disappear and giving governments more scope for fiscal stimulus. This would result in a loss on the central bank balance sheet, which it would obviate by creating money out of thin air. Direct lending to government: Governments could issue perpetual zero-coupon bonds and sell them directly to the central bank. This would allow for fiscal stimulus financed by a permanent increase in the monetary base without a balance sheet loss for the central bank. Lending to a public institution: Instead of direct lending, governments could sell perpetual zero-coupon bonds to a public institution (like an infrastructure bank). The central bank would then purchase those bonds from this public institution on the secondary market. This would avoid legal prohibitions, such as those in the euro area, against direct financing of government expenditure. "Trillion dollar coin": Governments could mint a high-value coin and sell it to the central bank. This measure was discussed during the United States fiscal cliff negotiations in 2012 as a way for the president to avoid a debt crisis caused by political brinkmanship with the legislature. "Citizenship credit": Governments could issue "citizenship credits" to all households, which the central bank would then buy for a set price. This fictitious asset swap would result in increased household wealth and could thus have a larger effect on demand than the above measures.7 The evidence from past tax cuts and stimulus measures suggests that households will spend at least 20 cents of every dollar received.8 Pure helicopter drops: The most radical solution would be to print money and distribute it directly to households. In theory, this would lead to a balance sheet loss on part of the central bank because no asset would be received in return. But, in reality, as Peter Berezin points out, from the central bank's point of view "money" is merely a bond which never matures and pays no interest. By definition, such a bond has a present value of zero. From the perspective of the household receiving the money, a one-dollar bill has a present value of $1. The use of actual helicopters to deliver the cash is optional. Legal Constraints One of our guiding principles during the euro area sovereign debt crisis was to ignore any argument that relied purely on the legal architecture at hand. "Laws are meant to be broken," particularly by those who penned them in the first place. Nonetheless, legal architecture is important in so far as it suggests which type of monetary financing is more or less likely in which economy. Table 1 examines the legal constraints that major central banks face when trying to adopt the aforementioned strategies. Based on our subjective read of the "strictness" of the respective institutional constraints, we assign each central bank a number between one and four. The higher the number, the more difficult it is to implement helicopter money legally. Table 1Legal Constraints To Debt Monetization In Developed Markets Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics Only direct lending to the government is strictly prohibited by most major central banks. For the Bank of Japan and the Bank of England not even this is the case, resulting in a very low legal constraint index score. In Japan, central bank governor Haruhiko Kuroda has recently said that "directly underwriting government bonds and monetizing fiscal deficits" is either illegal or "should not be done."9 However, the legal constraints seem relatively slight. Article 5 of Japan's Public Finance Law stipulates that "in special circumstances the BoJ shall be able to lend money within the amount approved by the Diet resolution." Articles 38.1 and 43.1 of the Bank of Japan Act allow the BoJ, in effect, to do whatever it deems necessary so long as it obtains the authorization of the prime minister and minister of finance. Hence, it is appropriate to conclude that legal constraints for the BoJ are minimal and that helicopter money could be implemented. This view is supported by the BoJ's Sept. 21 decision. The same conclusion can be drawn for the U.K. The existing "ways and means" facility is nothing other than direct government borrowing from the BoE. Even EU rules allow this facility, so the option remains open even if Brexit should ultimately fail to take place.10 The euro area is a more complicated case. Regarding the prohibition of debt monetization, Article 132.1 of the Treaty of Lisbon is very strict. However, Article 132.2 (the very next paragraph) provides a possible loophole, since it allows lending to a publicly owned credit institution.11 Therefore, a "European infrastructure fund" could be set up that would have access to the ECB's monetary financing and could deploy fiscal stimulus throughout the currency union. The ECB's Emergency Liquidity Assistance (ELA) facility - which provides funding to solvent euro area credit institutions facing liquidity problems - could be another way to avoid prohibitions against direct monetary financing by the ECB.12 The responsibility for the supply of ELA funding lies with national central banks, not the ECB. The ECB can only stop an ELA facility already under way with a two-thirds majority vote in its Governing Council. The ECB has argued in previous opinions that the ELA cannot be used to subvert the Article 123 prohibition against monetary financing, but circumstances may eventually alter those opinions.13 Most critically, national central banks provide liquidity under the ELA in exchange for collateral whose terms they set themselves (such as haircuts based on quality). As such, the national central bank could provide its financial institutions - including, say, a public infrastructure bank - with printed money in exchange for snow globes and comic books. And the ECB could stand aside and watch it all happen, with the Austrian and German members of the ECB Board feigning opposition with token votes against the Governing Council. Another possible loophole for the ECB arises from its Targeted Long Term Refinancing Operations (TLTRO). Under the guise of TLTRO, the ECB could provide perpetual zero-coupon loans to private banks while contractually binding them to extend these loans to any euro area citizen. Economist Eric Lonergan refers to this measure as cash transfers to households intermediated by banks.14 Finally, Article 20 of the Statutes of the ECB allows the Governing Council, by a two-thirds majority, to decide upon other operational methods of monetary control (besides the ones explicitly mentioned) in order to achieve price stability. In other words, if the ECB deems that its price stability mandate is threatened, it could vote itself the power to use helicopters. The alternative to stretching the existing law is to change it.15 Hence we will now assess the ease by which central bank rules can be changed. The possibility to amend the law is what earned the Fed a low legal constraint index in Table 1 above, since the key article has been amended several times in history. Furthermore, the proviso under which the Fed was allowed to purchase bonds directly from the Treasury was only ruled out in 1979.16 Far more difficult to change is the relevant part of the Lisbon Treaty, since that would require unanimity in the European Council and ratification by all member states, which would involve their domestic politics.17 This could be a major obstacle regarding any amendments to Article 132, as we elucidate below. Europeans will likely have to work within the rules available to them, which we think are quite malleable anyway. Finally, Sweden, unlike the United Kingdom, is bound to the Lisbon Treaty and receives no exception for direct lending to the government. Furthermore, the prohibition of monetary financing is also stated in the Sveriges Riksbank Act, making it even more complex to amend the law. The other two options - distributing cash to households and minting a high-value coin - are also of dubious legality in the Swedish case. Therefore, the Riksbank has in our view the highest legal constraints to helicopter money. Bottom Line: Legal constraints to debt monetization are far smaller than one would initially think. This is especially the case for the BoJ and BoE. The ECB would have to get creative in order to work within the law, but its statutes have wide enough holes for any helicopter to fly through. In addition, if one takes into account the raft of controversial, unconventional monetary and fiscal policies undertaken in the euro area in the recent past (Table 2), one is tempted to say, "Where there's a will, there's a way"! Table 2Europe: The Hurdle To Heterodoxy Is Low Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics Political Constraints A policy as controversial as debt monetization requires political capital for implementation. In economies where legal and political constraints exist, a crisis will be necessary to overcome them. As such, we agree with our colleague Martin Barnes, who has argued that debt monetization is step three of a process where step two is a deep economic crisis.18 The constraints are not uniform across economies. Countries where households mostly struggle with the twin ills of debt and deflation would welcome higher inflation, but those where households are mostly savers would naturally not. On the other hand, even savers who depend on interest-bearing income for retirement would likely favor unorthodox monetary policy that allows interest rates to rise eventually. We therefore look at three broad factors when assessing the political constraints to monetary financing: Overall trust in monetary institutions; Household savings rate; Financial asset composition of households. Japan The two main factors that led to high saving rates in Japan, i.e. sharply rising incomes and favorable demography, have vanished (Chart 5). Japanese household savings rates have declined dramatically since the 1980s (Chart 6).19 Of course, Charts 7 and 8 show that the financial net worth of households is still massive and hence Japanese households may still prefer low inflation rates.20 But the population's aversion to inflation may not be as great as is assumed by conventional wisdom. Chart 5Japan's Demographic Dividend Is Over ... Japan's Demographic Dividend Is Over ... Japan's Demographic Dividend Is Over ... Chart 6... Leading To A Savings Rate Decline bca.gps_sr_2016_09_26_c6 bca.gps_sr_2016_09_26_c6 Chart 7Japanese Households Are Still Wealthy Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics Chart 8Japan: Public Debt Vs. Private Wealth bca.gps_sr_2016_09_26_c8 bca.gps_sr_2016_09_26_c8 After all, Japanese households suffer in a low interest-rate environment because their financial assets are mainly composed of rate-sensitive products (Chart 9). Moreover, high government debt levels risk imperiling future entitlement spending. As such, the public may support policies that inflate away government debt so that the public sector can pay out pensions in future. Chart 9Only American Pensioners Are Ambivalent About The Pain Of Low Interest Rates Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics For the past four years, policies to boost inflation in Japan have received strong popular support. How else can we explain the continued political success of Prime Minister Shinzo Abe and his government, the most impressive run in twenty-first century Japan (Chart 10)? The inflation goal of Abenomics is clearly stated, not obfuscated by technocratic jargon, so it cannot simply be said that the public has been deceived. At the very least it suggests that the public understands the tradeoffs between inflation and deflation and is starting to favor the former over the latter as the household sector draws closer and closer to net debtor status. Europe The economies of the euro area have substantially different household saving rates. As such, political constraints to monetary financing are not equal across the currency union. Households in countries like Germany and France save a large fraction of their disposable income. In Spain and Italy, only a fraction of income is saved, whereas Greek and Portuguese households are net borrowers (Chart 11). Unsurprisingly, German trust in the ECB seems to be highly negatively correlated with increases in money supply (Chart 12). On the other hand, trust in the ECB in the peripheral states has recovered somewhat since the various efforts by the central bank to support their economies (Chart 13) through non-conventional monetary policy. Chart 10If Abenomics Is So Unpopular,##br## Why Is Abe Popular? bca.gps_sr_2016_09_26_c10 bca.gps_sr_2016_09_26_c10 Chart 11Discrepancy In Savings##br## Rates In The Euro Area Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics Chart 12Germans Fret About Easy Money bca.gps_sr_2016_09_26_c12 bca.gps_sr_2016_09_26_c12 Chart 13Trust In ECB Recovering bca.gps_sr_2016_09_26_c13 bca.gps_sr_2016_09_26_c13 Many pundits and commentators have also pointed out that Germans will not accept higher inflation rates due to traumatic history. The 1922-23 hyperinflation is often blamed for the eventual collapse of the Weimar Republic. But this is a false narrative. The Weimar Republic did not suffer hyperinflation because of money printing but because its manufacturing base was destroyed by the First World War. This massive supply loss was exacerbated by the French and Belgian occupation of the Ruhr in January 1923 as punishment for unpaid reparations. This was a German industrial region where much of its surviving capacity was located. The cumulative loss of supply caused a price shock that the central bank attempted to assuage with money printing. Money printing was therefore primarily a consequence of a massive decline in supply, leading to rampant price inflation. In fact, it was the austerity policies of Chancellor Heinrich Brüning following the Great Depression that led to the rise of populism in Germany, not the money printing undertaken a decade earlier. At the moment, this narrative may not be the dominant one in Germany. But historical interpretations can change on a dime when circumstances demand it. The fact remains that the ECB has effectively pursued an activist monetary policy despite the supposed resistance of Germany. How do we explain this? First, EU integration remains a geopolitical priority for Germany, as well as other European states. Individual European countries are no longer capable of exerting a significant global influence independently and have sought to aggregate geopolitical power as a result.21 Whether the project will succeed may be debatable, but the reality that it has sound geopolitical logic is not. Second, Germany's export-oriented economy is particularly vulnerable to protectionism and competitive currency devaluation by its top trade partners. These policies are precisely what Berlin would suffer if it were to abandon its currency-union peers by choosing "exit" over the printing press. Italy and France would immediately devalue their currencies against the new Deutschmark, and would likely impose outright trade barriers and tariffs subsequently. In short, if Germany will not help sustain the low financing costs of France and Italy through currency union, then it will be denied access to their markets. Founders of the EU understood this dynamic, which is why multiple (unsuccessful) attempts were made to peg European currencies, first to the U.S. dollar, and later to the Deutschmark, prior to the advent of the euro. We suspect that if the euro area's sovereign-debt crisis were to arise anew, German policymakers would have to explain the tradeoff between staying true to historical narratives on hyperinflation and sustaining Germany's export-addicted economy to their public. The contest is not even close. Historical revisions would be revised. In addition, German households are, much like their Japanese peers, dependent on high interest rates for saving (see Chart 9 above). As such, they may eventually relent to a set of unorthodox policies that raises interest rates in future. Nevertheless, regardless of German history and geopolitics, the reality is that the German public is not ready for monetary financing today. As such, we suspect that the ECB will only fire up the helicopters once the integrity of the euro area is threatened anew. Thankfully for ECB policymakers, Japan will likely have already undertaken such heterodox monetary policy by that time, allowing the ECB to piggyback on BoJ efforts. The U.S. In contrast to Japan and the euro area, deflation is not as much of a risk in the United States and interest rates have not been pushed into negative territory (Chart 14). Therefore, the case for debt monetization is much weaker. In addition, U.S. households are increasingly preferring saving instead of spending (Chart 15), a dynamic that may impede the transmission mechanism of helicopter drops, which ultimately rely on household spending. Chart 14Inflation Remains Low, But Has Bottomed Inflation Remains Low, But Has Bottomed Inflation Remains Low, But Has Bottomed Chart 15U.S. Households Prefer To Save bca.gps_sr_2016_09_26_c15 bca.gps_sr_2016_09_26_c15 Despite their preferences for more savings, however, the actual savings rate for the bottom 90% households in terms of wealth is essentially zero. In fact, most U.S. households are concerned about poor job prospects, low wage growth, and high debt levels. How else can we explain the support for Donald Trump and Bernie Sanders?22 As such, the aggregate household savings rate may not be the best measure of political constraints to monetary financing in the U.S. It may overstate the preferences of the minority of the population that actually saves. The United Kingdom Chart 16Public Is Satisfied With BoE bca.gps_sr_2016_09_26_c16 bca.gps_sr_2016_09_26_c16 As in the U.S., interest rates remain positive in the U.K. In addition, growth is tolerable and the unemployment rate is near the BoE's definition of full employment (5%). Therefore, pressure for drastic measures is weak, albeit higher after the Brexit referendum shock than before. According to Chart 16, individuals are satisfied with the BoE and trust the bank to take the appropriate measures to achieve the inflation target, thus giving the BoE high political capital. British households would suffer under lower interest rates because they are heavily reliant on pension funds and life insurance for income (see Chart 9 above). Therefore, one could argue that they would rather support helicopter money than negative interest rates. Mark Carney, the BoE governor, has ruled out helicopter money even since the Brexit vote, arguing that the available stimulus tools are sufficient and "there's not a need for such flights of fancy here in the UK."23 Hence the chances of debt monetization may be low for now, assuming that the likely post-referendum recession is not very deep. However, they would increase if a shock were to hit the British economy. Just such a shock could occur after the U.K. formally exits the EU, which may still be two years away. Switzerland Swiss households save a high fraction of their net income (see Chart 6 above). In addition, the Swiss government's debt-to-GDP ratio is very low (34% as of 2015). Therefore, the current deflation is not as much of a burden for Switzerland as it would be for indebted countries. On the other hand, negative interest rates weigh heavily on pension funds, which account for a large fraction of households' financial assets (see Chart 9 above). Moreover, the overvalued Swiss franc drags on the Swiss economy. Instead of buying euros to stabilize the EUR/CHF exchange rate, the SNB could distribute this money to households. Swiss Trade, a powerful union representing the interests of 3,800 retail companies and over 10% of the Swiss labor force, has made this demand. So far, however, this kind of pressure from domestic interest groups has not made any difference. The situation could change if another sovereign-debt crisis were to hit the euro area and put further upside pressure on the Swiss franc, a safe haven asset. Sweden The Swedish population has great trust in national institutions, especially in the Riksbank.24 Its political capital is therefore large. Nevertheless, since there is no danger of deflation and the economy is doing well, it would be hard to justify such extreme policy measures. Moreover, Swedish households increased their savings rate drastically in the last few years (see Chart 6 above), making them more averse to inflation than they were a decade ago. In addition, there is no pressure for higher interest rates, since households are heavily invested in equities (see Chart 9 above), which profit from low interest rates. Political constraints are thus very high. Bottom Line: Our analysis shows that Japan has the lowest legal and political constraints to debt monetization, and recent events suggest it has begun laying the framework. In addition, if another euro crisis were to occur, the ECB and the SNB might be forced to join the BoJ in mustering the helicopters. On the other hand, it would be rather surprising in the short and medium term if the Fed, BoE, or Riksbank took concrete steps toward debt monetization. Uncharted Waters? Would helicopter money mark a dangerous voyage into uncharted waters? Not really. Western governments used debt monetization several times in the twentieth century. During the Second World War, various countries printed money to finance war costs. In the U.S., debt monetization continued after the war with the Fed purchasing government bonds directly from the Treasury from time to time. It was only in April 1979 that these purchases ceased.25 An even more striking example is Italy, which monetized its debt down to 1981: the Bank of Italy was actually forced by law to purchase all public debt not taken up by the market.26 In Canada, the Bank of Canada financed public debt down to the 1970s. Between 1935 and 1939, the BoC funded a remarkable two thirds of public debt and, during the Second World War, fiscal and monetary policy effectively merged. Inflation never exceeded 5% until the early 1970s, indicating that monetary financing can contribute to positive non-inflationary economic outcomes if conditions (and management) are right.27 Another example of a successful implementation of helicopter money is the expansionary policy undertaken by former Japanese Finance Minister Takahashi Korekiyo between 1932 and 1936. His debt monetization program is said to be the prime reason why Japan recovered so quickly from the Great Depression. At the same time, the example is instructive about the risks of helicopter money: Takahashi was ultimately assassinated by the military when he changed course on debt monetization, and the whole episode fed into Japan's slide into fascism.28 To these substantial risks, we will now turn. Bottom Line: Helicopter money is not merely theoretical. Major economies - including responsible ones like Canada and Italy - used debt monetization into the late twentieth century. Dangers Of Releasing The Kraken Chart 17Unlimited Resources ##br## Undermine Democracy Unleash The Kraken: Debt Monetization And Politics Unleash The Kraken: Debt Monetization And Politics Democracy is a process by which various interest groups and segments of the population bargain over limited resources. Democracies are successful because they institutionalize the bargaining process so that it legitimizes the decisions over who gets what. Countries with unlimited resources tend to be authoritarian regimes (Chart 17). This phenomenon is referred to as the "resource curse" and is well documented in political science. Essentially, countries that are endowed by massive natural resources can distribute the wealth to all interest groups and all segments of the population, thus obviating the need to institutionalize any part of their bargaining process. The ruling elite stays in power because it can keep buying off the population and stave off demands for representation.29 We are not saying that Japan or Europe would turn fascist because of helicopter money, but rather that it will be difficult to restrain the policy once it is unleashed. When resources become unlimited, how would democratically-elected policymakers manage to limit them? It is easy to tell various interest groups - pensioners, veterans, single mothers, low-income households - that they cannot receive what they want when the resources are limited. But the danger of helicopter money is that once the decision is taken to drop the cash from the air, the decision of who gets money for what will become extremely politicized and polarizing. Proponents argue that just as monetary policy has become independent of government, so too can fiscal policy. For example, the central bank could decide how much fiscal spending is needed to achieve its inflation target and then print the requisite amount, leaving it up to political decision-makers to decide how to divvy out the manna from heaven. The problem is that monetary policy has already become politicized in a number of countries, mainly in the emerging markets, and pressure has been mounting in the developed world. That pressure would become extraordinary once central banks start creating resources from thin air. The essence of representative government - popular control of fiscal powers - would erode. Our colleague Dhaval Joshi, Chief Strategist of European Investment Strategy, has also posited that the population could easily lose trust in institutions, even the currency itself, if the experiment gets out of control.30 This is unlikely in its first iteration, but it could happen if the process becomes politicized, which we think would happen. The other problem is that the effort to print money could become a source of geopolitical conflict if it produces a competitive debt monetization regime. For example, if the BoJ implements helicopter money and weakens the yen, China could counter by devaluing the renminbi. Since there are natural limits to how much money can be printed before inflation takes off, and neither country would want to destroy the value of its currency, the two sides might seek to counter helicopter devaluations via protectionism. Bottom Line: Debt monetization and helicopter money would short-circuit the democratic process itself. The entire point of representative government and democratic institutions is to allow for bargaining over limited resources. Once the option of unlimited resources becomes real, it will be very difficult to decide who gets to benefit. It would take a very strong government indeed - perhaps an authoritarian one - to impose limits. Investment Implications Debt monetization is not going to be fully implemented in any major economy until a serious economic crisis arrives. As such, this research effort is largely exploratory. We have presented a list of legal and political constraints that we believe will determine the sequence and the form of helicopter money in major economies. We agree with our colleague Peter Berezin that Japan may attempt some form of debt monetization in 2017-18. The monetary policy framework is already being laid. In the long term, the world is slowly moving away from its current deflationary paradigm. On the geopolitical front, we are seeing less, not more, globalization. Global multipolarity is a constraint to geopolitical stability, and this is as true today it has been over the past 200 years. We identified this trend in a 2014 Special Report, "The Apex Of Globalization: All Downhill From Here," which we encourage our clients to re-read.31 On a shorter timeline, we are seeing policymakers move away from austerity and towards greater willingness to use fiscal policy. The U.S. presidential election is instructive, as the issues of budget deficits and debt sustainability have been completely ignored throughout the campaign, despite their prominence as recently as 2012. Other major economies, including Europe, are moving away from austerity. More government spending, less globalization, and more unorthodox monetary policy all point to the end of the current deflationary era. As a play on this theme, we would recommend that investors take long positions on Japanese and German inflations swaps. We also think that it is time to turn structurally bullish on gold.32 In addition, we recommend going short JPY/long USD, even though markets will initially test the BoJ and drive the yen higher. We are renewing our strategic long Japanese stocks trade, hedged for currency, to capitalize on the ongoing paradigm shift in Japan that we identified in 2012.33 Nicola Grass, Contributing Author Marko Papic, Managing Editor marko@bcaresearch.com 1 Specifically, the BoJ pledged to keep the 10-year JGB yield at around zero, at least until inflation stabilizes at a rate above 2%. This decision amounts to a commitment to correct past inflation undershoots and to keep 10-year yields at zero regardless of the supply of new debt. Please see "Japan: Don't Count Abenomics Out," in Geopolitical Strategy Monthly Report, "Who's Afraid Of Big Bad Trump," dated August 10, 2016, and Geopolitical Strategy Special Report, "Japan: The Emperor's Act Of Grace," dated June 8, 2016, available at gps.bcaresearch.com. 2 Please see Global Investment Strategy Weekly Report, "Helicopter Money" A Semi-Hostile Q&A," dated May 13, 2016, "Escape from the Land of The Rising Yen," dated April 15, 2016, "Japan: On The Road to Debt Monetization," dated February 5, 2016, and Global Investment Strategy Outlook, "Ten Predictions For The Rest Of The Year," dated April 1, 2016, available at gis.bcaresearch.com. In addition, please see Foreign Exchange Strategy Weekly Report, "Down the Rabbit Hole," dated April 15, 2016 available at fes.bcaresearch.com. 3 Please see The Bank Credit Analyst Special Report, "The Case Against More Monetary Mischief," dated August 16, 2016, available at bca.bcaresearch.com. 4 The term helicopter money refers to the statement by Milton Friedman in his 1969 paper "The Optimum Quantity of Money," where he proposes that a central bank could throw money out of a helicopter to increase inflation. 5 The "Ricardian Equivalence" theory suggests that individuals are forward looking and thus will assess that today's tax cuts or fiscal expenditure must be financed by tomorrow's higher tax burden. Since the intertemporal budget constraint is binding, rational individuals will not necessarily increase their current consumption even while benefiting from expansionary fiscal policy. 6 See Willem H. Buiter, "The Simple Analytics of Helicopter Money: Why It Works - Always," Economics E-Journal 8 (2014), pp. 1-38. Available at dx.doi.org. 7 Please see Global Investment Strategy Weekly Report, "Escape from the Land of The Rising Yen," dated April 15, 2016, available at gis.bcaresearch.com. 8 Please see Laura Jaramillo and Alexandre Chailloux, "It's not all Fiscal: Effects of Income, Fiscal Policy, and Wealth on Private Consumption," IMF Working Paper 15/112 (May 2015), available at www.imf.org. 9 Please see Bank of Japan, "'Comprehensive Assessment' of the Monetary Easing: Concept and Approaches," dated September 5, 2016, available at www.boj.or.jp/en. 10 According to Protocol No. 15, Article 10 of the Lisbon Treaty, the "Government of the United Kingdom may maintain its 'ways and means' facility with the Bank of England if and so long as the United Kingdom does not adopt the euro." 11 Article 132.2 of the Treaty of Lisbon: "Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions." 12 ECB, "Emergency liquidity assistance (ELA) and monetary policy," dated 2016, available at www.ecb.europa.eu. 13 Please see ECB, "Opinion of the European Central Bank of 21 November 2008," dated November 21, 2008, https://www.ecb.europa.eu/ecb/legal/pdf/en_con_2008_74_f.pdf. 14 Eric Lonergan, "Legal helicopter drops in the Eurozone,"dated February 24, 2016, available at www.philosophyofmoney.net. 15 Various academics argue that an explicit allowance of monetary financing would not undermine the independence of central banks as long as governments decide how the money will be spent and central banks decide how much money to print. See Buiter (above, note 4) and Adair Turner, "The Case for Monetary Finance - An Essentially Political Issue," 16th Jacques Polak Annual Research Conference (2015), available at www.imf.org. See also "Helicopter Ben" Bernanke, "Some Thoughts on Monetary Policy in Japan," Federal Reserve, Speech at Japan Society of Monetary Economics, dated May 31, 2003, available at www.federalreserve.gov. 16 Please see U.S. Code 355, "Purchase and sale of obligations of National, State, and municipal governments," Legal Information Institute, accessed 2016, available at www.law.cornell.edu. 17 Title 6, Article 48.6 of the Lisbon Treaty. 18 Please see footnote 3 above. 19 The longstanding Japanese household opposition to inflation has been shifting in recent years, as revealed by voter behavior since 2012. Yet some elements of the trend persist, as in the BoJ's public survey in April 2016, in which over 80% of respondents argued that a general price increase would be unfavorable. Please see Martin Feldstein, "Japan's Savings Crisis," Project Syndicate, dated September 24, 2010, available at www.project-syndicate.org. 20 See Bank of Japan, "Results of the 65th Opinion Survey on the General Public's Views and Behavior (March 2016 Survey)," dated April 18, 2016, available at www.boj.or.jp/en. 21 Please see Geopolitical Strategy Special Report, "The Euro And (Geo)politics," dated February 11, 2015, and Geopolitical Strategy Special Report, "Europe's Geopolitical Gambit," dated November 2011, available at gps.bcaresearch.com. 22 Please see BCA Geopolitical Strategy Special Report, "The End Of The Anglo-Saxon Economy," dated April 13, 2016, available at gps.bcaresearch.com. 23 Please see Will Martin, "Carney: We Will Take 'Whatever Action Is Needed,'" Business Insider UK, dated August 4, 2016, available at uk.businessinsider.com, and Jake Cordell, "Mark Carney dismisses helicopter money as a 'compounding Ponzi scheme,'" City AM, dated April 19, 2016, available at www.cityam.com. 24 Please see European Commission, "Introduction Of The Euro In The Member States That Have Not Yet Adopted The Common Currency," Flash Eurobarometer 418 (May 2015), p.44, available at ec.europa.eu. 25 Kenneth Garbade, "Direct Purchases of U.S. Treasury Securities by Federal Reserve Banks," Federal Reserve Bank of New York, Staff Report No.684, 2014, available at www.newyorkfed.org. 26 Guido Tabellini, "Central bank reputation and the monetization of deficits: The 1981 Italian monetary reform," Economic Inquiry 25 (1987), p.185-200, available at onlinelibrary.wiley.com. 27 Josh Ryan-Collins, "Is Monetary Financing Inflationary? A Case Study of the Canadian Economy, 1935-75," Levy Economics Institute, Working Paper No. 848 (2015), available at www.levyinstitute.org. 28 Myung Soo Cha, "Did Korekiyo Takahashi Rescue Japan from the Great Depression?" Hitotsubashi University, Institute of Economic Research Discussion Paper Series No. A395, dated September 30, 2000, available at hermes-ir.lib.hit-u.ac.jp. 29 Please see Jeffrey Sachs and Andrew Warner, "Natural Resource Abundance and Economic Growth," NBER Working Paper 5398 (December 1995), available at www.nber.org. 30 Please see European Investment Strategy Weekly Report, "The Case Against Helicopters," dated May 5, 2016, available at eis.bcaresearch.com. 31 Please see BCA Geopolitical Strategy Special Report, "The Apex Of Globalization: All Downhill From Here," dated November 12, 2014, available at gps.bcaresearch.com. 32 Please see footnote 2 above. 33 Please see BCA Geopolitical Strategy Special Report, "Japan's Political Paradigm Shift: Invest Implications," dated December 21, 2012, available at gps.bcaresearch.com.

With 88 days to go until the U.S. presidential election our client meetings are starting to steer towards "all Trump, all the time." In this report we present evidence that Trump's electability is correlated with the chief global safe haven, the 10-year Treasury. Markets may be overreacting, however. Trump has a chance, but Clinton is the clear favorite. We also bust five myths about China's political system, in a continuation of our coverage of rising geopolitical risks in East Asia.

The median voter theory is one of the few genuine theories of political science. It assumes that voters have limited policy priorities and that politicians want power. Therefore the latter will adjust their stances to satisfy the largest swath of voters. The median voter in the Anglo-Saxon world is shifting to the left, and regardless of what happens in the Brexit referendum or the U.S. election, this shift will be the most consequential development for markets.

Clients should forgive us for being too gloomy at the start of the year -- it is difficult to be optimistic in the dead of a Montreal winter. However, with springtime comes the reflation trade, born on the wings of massive Chinese fiscal and credit expansion. In this report, we discuss how long (not very) the trade can go (and how to play it). Our In Focus feature returns to pessimism, with a discussion of why the Anglo-Saxon laissez-faire economic model may be in for a big pendulum swing.