Periodic interventions are made by commentators over time, who repeat the same thing over and over – usually some prophecy that a currency (e.g., the yen or dollar) will soon collapse, and life goes on until they Make the same prediction, the result is never. Mainstream media likes to give these characters a platform because the headlines are sensational, which I guess sells “units” for the company. The most recent to see is Mr. Roubini of the Financial Times, who often predicts a dollar crash. I think it’s time to miss him. A topic associated with hysteria, about which ordinary people seem to fret, but apparently don’t even understand the first principles involved, is the old rumor – that central banks are losing money. For most, this becomes a bit of an abstraction relative to the headlines of a Roubini-style currency collapse, but the mainstream media still manages to create a doomsday scenario where somehow the central bank is about to fail and the government will have to bail out They, taxes and debt will rise, and somehow, eventually, our children and grandchildren will find themselves penniless while trying to pay off the debts owed by our current government. Recent BIS Bulletin Articles (No. 68) – Why are central banks reporting losses? does it matter? (posted Feb 7, 2023) – Related to this issue. Conclusion: Not much to see here.
Why are central banks reporting losses?
These are just manifestations of accounting conventions.
The sequence of events leading to this situation is as follows:
1. Various names such as quantitative easing and yield curve control mean that the central bank enters the bond secondary market, and national bonds are freely bought and sold by speculators, buying bonds of different maturities (5-year, 10-year, etc.) in large quantities.
2. So central banks credit the money they create with the number key to bank reserve accounts and record bond purchases at the value of the bond on the asset side of the balance sheet (measuring only the bank’s assets and liabilities/capital) at the time of purchase.
3. As a result, over time, as the bond-buying program expanded, assets rose sharply.
For example, here are the assets of the Federal Reserve Bank of the United States from July 30, 2007 to January 31, 2023 (source).
The top line (blue) is total assets, while the line directly below it is directly held securities, ie bond purchases.
A similar pattern was seen with the Bank of Japan (1998-January 2023 data), as did many central banks participating in bond-buying programs.
4. The BIS notes that bond purchases are facilitated by central banks providing “interest-bearing commercial bank reserves” (as above), which means two things:
– They pay commercial banks a return that is close to the market’s short-term cash return, which in effect means that the procedure is simply a transfer of numbers from one account at the central bank (outstanding interest-bearing government debt) to another (interest-bearing government debt) to prepare gold) – meaning banks are indifferent to holding bonds or reserves.
– Non-interest bearing liabilities as a percentage of total liabilities on central bank balance sheets have also declined.
For example, before the global financial crisis, the Federal Reserve did not provide support for excess reserves of commercial banks.
5. These macroeconomic policy decisions taken by central banks “affect their profits and losses as a by-product”. how?
6. To reduce inflationary pressures by raising interest rates, which would have abated regardless of interest rates, central banks have:
– Push bond yields up and bond prices down (remember bond prices and yields are inversely related) so that the value of their current bond holdings goes down.
– lowered their net interest income because “a significant portion of their liabilities are tied to the policy rate” – by paying interest on excess reserves in the system.
7. As a result, the adoption of an accounting treatment that recognizes “changes in market value when calculating net profit” has resulted in the following:
A number of central banks have recently reported losses, and more are expected… in some cases, losses are considerable based on accounting methods and could lead to negative equity.
Banks that have reported losses include: the Reserve Bank of Australia, the National Bank of Belgium, the Bank of England, the Bank of Japan, ABN Amro, the Central Bank of New Zealand, the Riksbank and the Federal Reserve.
The accounting loss (figure) is written off against the existing capital of the central bank, so if the figure is large enough, the bank will enter a period of “negative equity” – that is, it does not hold enough current capital to match the accounting loss figure.
Sounds scary.
It is not.
I’ve written about him before:
1. Central Banks Can Run In Negative Equity Forever (September 22, 2022).
2. The ECB can’t go bankrupt – get over it (May 11, 2012).
3. The scam of ECB independence (October 24, 2017).
4. Repeat after me: central banks could lose a lot, who cares (February 16, 2022).
5. The central bank should write off all government debt (February 15, 2021).
6. Banque de France should write off its holdings of national debt (April 24, 2019).
7. The Fed is on the brink of bankruptcy (it’s not!) (November 18, 2010).
8. Better to study the mating habits of frogs (September 14, 2011).
The date trail of these past blogs shows just how often this topic has been featured in the mainstream media – old school!
does it matter?
The BIS understands that:
1. “Central banks are public institutions with a policy mandate; they typically transfer excess profits to fiscal authorities” – so ultimately they are part of the government and inherit money issue status.
Economic and Monetary Union is a bit different because none of the member governments has sovereignty over the euro area. Only the ECB has currency-issuing capacity, and France, for example, cannot order it to use that capacity.
For countries like Australia, the central bank is a product of the state.
2. For central banks, “the usual notions of solvency do not apply” – they are not commercial entities accountable to their shareholders.
3. For whatever reason, many central banks have arrangements with the government’s treasury or finance department to compensate them for their losses. what does that mean? Simply put, the government will always “make up” the loss in the accounting sense – the numbers flow from the government’s left pocket to its right pocket.
4. Other central banks have not followed this path, “note that they are irrelevant from the perspective of the overall public sector balance sheet”. That is, an explicit recognition that the central bank is part of the government, despite all the claims about “independence”.
BIS writes in this regard:
Since central banks typically remit some or all of their profits to fiscal authorities, they are part of a “comprehensive” public sector financial picture…Recent losses at many central banks have resulted in reduced transfers to fiscal authorities or no transfers at all, in some The situation may last for several years.
From right to left pocket and vice versa.
5. Further:
…Central banks do not seek profit and cannot go bankrupt in the traditional sense, since they could in principle issue more money to meet domestic currency obligations and, because of their unique purpose, do not face minimum regulatory capital.
In other words, unlike non-government corporations, governments that issue money never run out of money. There are no financial restrictions.
However, the BIS sneaks this fiction into the story:
… central banks are protected from court-ordered bankruptcy and supported by (indirect) taxpayers.
Taxpayers are not part of the story.
Taxes reduce non-government spending capacity (as well as other functions – such as discouraging people from smoking).
They don’t fund or support anything.
In principle, from a macroeconomic perspective, taxes help create room for real resources that governments can invest without causing demand-pull inflation.
Central banks are supported by governments because they are part of governments – that is the reality.
6. “These provisions enable central banks to operate successfully without capital and to sustain losses and negative equity over time.”
The Bank for International Settlements provides several historical examples.
But then things fell apart
BIS then set out to validate their conclusions:
However, in some exceptional cases, misunderstandings and political-economic dynamics may interact with losses to damage the central bank’s position. If the macro economy is mismanaged and the country lacks credibility, losses could weaken the central bank’s position, which could jeopardize its independence and could even lead to a currency collapse.
No example is given. Why?
Because it’s hot air.
Yes, politicians may exaggerate the story to hurt other politicians.
Financial markets may talk a lot about ditching the currency, but if the central bank stands its ground, as Japan has done, then “market players” lose.
The Roubini faction has been predicting hell for Japan and has claimed that the BoJ will soon back off and respond to market demands for rate hikes and the abandonment of yield curve control.
My most recent post on the subject was – Bank of Japan continues to show who has the power (January 26, 2023).
Financial commentators and gamblers are also hoping that the central bank’s policy course will shift in a market-friendly direction when the current governor (Haruhiko Kuroda) is about to retire.
wrong again.
With Haruhiko Kuroda out, the government appears set to appoint a BOJ deputy governor, Masaka Amamiya, who will not change policy direction at all given his publicly expressed public views.
Yen spreads have diverged as the yen has depreciated since the Fed started raising interest rates.
That was totally predictable.
But there is a limit to the depreciation, with the recent strengthening of the yen – again entirely predictable – when it became clear that the banks would not let financial market gamblers reap the profits of their bets.
So in the end, central bank losses themselves will trigger some currency crises.
They may do so if the government is weak-willed and policy direction is confused. But that’s just to say that financial markets will prey on governments they think will back off and sanction speculative bets.
The BIS also continues to emphasize the need for “central bank independence,” which requires “well-designed allocation rules to manage transfers from the central bank to the government, the process of dealing with loss events or declines in profitability, and the clarity of risk-sharing arrangements.” sex if it exists.”
In other words, the smoke screen conceals the real situation.
That is, the central bank is part of the government, and money-issuing power always favors the government, which can move amounts of money around its internal accounting structures at will without any significant consequences.
in conclusion
There will certainly be more coverage in the mainstream media.
Central banks lose money because of their own policies.
But those losses are meaningless.
More importantly, central banks now make substantial income transfers to commercial banks (and indirectly to their shareholders) through returns paid on excess reserves.
In addition, the central bank is inflicting a huge loss of income on low-income mortgage holders due to the rate hikes.
They should immediately return to zero excess reserve support and stop raising interest rates.
Enough for today!
(c) Copyright 2023 William Mitchell. all rights reserved.
