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Central banks can operate with negative equity forever – Bill Mitchell – Modern Monetary Theory

The global media has recently been full of stories about how central banks took huge losses and risked their solvency, and then analyzed the dire consequences of government bailouts for said banks. Of course it’s all ridiculous nonsense. It’s like a daily news report on the threat of ships falling from the edge of the earth. But we know much more than that. But in economic commentary, there are definitely a lot of flatlanders. One day humanity (if it survives) will look back at this period and wonder how their predecessors were so ignorant of basic logic and facts. Those 2022 humans are a bunch of stupid people.

background reading

I’ve considered this topic before:

1. The ECB can’t go bankrupt – get over it (May 11, 2012).

2. The ECB Independence Scam (24 October 2017).

3. Repeat with me: Central banks could take huge losses, who cares (February 16, 2022).

4. The central bank should write off all government debt (February 15, 2021).

5. Banque de France should write off its holdings of national debt (24 April 2019).

6. The Fed is on the brink of bankruptcy (not!) (November 18, 2010).

7. Best study of the mating habits of frogs (September 14, 2011).

Reserve Bank of Australia loses money!

The Reserve Bank of Australia released its – Review the bond purchase program (Published 21 September 2022) – The report says the RBA purchased:

… Australian, state and territory government bonds totalled A$281 billion between November 2020 and February 2022.

This is the bulk of the debt issued during that period.

They concluded that the action “lowered Australia’s overall interest rate structure and supported confidence in the economy in the face of serious downside risks.”

The commentary provides this chart to show the global scale of these bond-buying programs.

It’s hard not to conclude that these programs are “enormous” relative to the debt issued and the size of the economy.

It also offers a view on the claim that the public debt ratio has risen above an acceptable level of solvency.

First, it is debt that the government effectively issues to itself. Gymnastics like left pocket right pocket.

Second, the right pocket is always able to pay the left pocket, and the left pocket then remits the aforementioned fee back to the right pocket.

The comment also refuted claims that the RBA’s quantitative easing program caused or exacerbated the current inflationary event.

They show that the so-called “quantity theory of money” used by monetarists and others does not work because “there has been no stable relationship between monetary aggregates and economic activity or inflation in Australia for decades”.

1. Velocity of circulation “declined over time, falling sharply in 2020” – which means the stock of money turns around more slowly in transactions.

2. “Furthermore, different components of the money supply can move independently over time. While the BPP leads to a sharp increase in ES balances and “base” money, the broader money supply increases associated with nominal spending in the economy It’s not that big.”

Therefore, the QTM cannot be used as a framework for explaining current inflation – Exit Monetarism and other novels by Milton Friedman.

What got the media excited was the following statement:

For the RBA, bonds purchased pay a fixed return, while exchange-settled (ES) balances created to pay bonds pay interest that varies by monetary policy setting. As interest rates rise, the RBA will incur financial costs as a result. The final cost will only be known when the last bond purchased matures in 2033, and various scenarios are presented in this review. In most cases, banks will be unable to pay dividends to the government for several years.

ES balances are what Americans call bank reserves.

A bond-buying program simply transfers assets—bondholders’ bonds and reserves—to their bank accounts.

The question then posed by the media is what this “financial cost” means.

This is the sum of known returns – bond yield and par value – unknown cost, which is related to the interest paid on ES balances that are sensitive to future monetary policy changes.

RBA estimates

Overall, the cumulative financial costs to banks of the scheme are $35 billion, $42 billion, $50 billion, and $58 billion over the period to 2033 under the scenario of the lowest-to-highest ES rate path.

Wow, that sounds terrible.

The media certainly thinks so.

The BBC report on censorship (21 September 2022) features sensational headlines – Covid: RBA bond purchases hit by $30bn.

Sounds terrible.

That is, if you don’t understand something.

Importantly, the RBA noted:

The Reserve Bank board considered whether to seek government compensation for BPP, but deemed it unnecessary. The Board recognized that the reparation would shield the Bank’s balance sheet from the impact of the BPP, but not the balance sheet of the entire public sector; the impact of the BPP would simply be transferred from the bank’s balance sheet to the government’s assets Balance Sheet.

Left and right pockets.

RBA Deputy Governor Michelle Bullock spoke in Sydney about – Speech: Review of Bond Purchase Program.

She focuses specifically on erroneous claims about RBA losses and outlines how accounting losses are handled.

She pointed out that all discussions about the RBA capital reserve have been in consultation with the Federal Treasurer (left and right pockets).

It is the “treasurer” who “decides” how much of any positive gains the RBA receives on the transaction goes into the capital reserve, and how much goes into the Treasury account as a “dividend”.

and deduct accounting losses from capital reserve

Therefore, in the 2021/22 financial year, the RBA recorded:

…$36.7 billion in accounting losses…

This means the RBA’s losses are greater than the current reserves ($21 billion), the deputy governor said:

…meaning the bank has negative equity.

Is that the problem?

Not at all.

The Deputy Governor told us why:

If any business entity’s equity is negative, the assets will not be enough to cover the liabilities, so the company will not be able to continue as a going concern. But central banks are not like commercial entities. Unlike normal businesses, in a country like Australia, central banks do not have going concern issues. Under the Reserve Bank Act, the government guarantees the liabilities of the Reserve Bank. Also, because of its ability to create money, the bank can continue to meet its obligations when it matures, so it is not insolvent. Therefore, a negative equity position does not affect the ability of the Reserve Bank to carry out its mandate.

So no problem.

End of story.

The current Treasurer has apparently agreed to forgo “dividends” so that future RBA “profits” will only restore accounting capital, but as the Deputy Governor admitted:

…banks can continue to operate in negative equity…

Forever, it wants without losing any capacity or functionality.

But it seems journalists around the world don’t understand reality.

For example, the Toronto Star ran a story written by its economic experts (once you read the article, one might say so-called experts)— For the first time in its history, the Bank of Canada has lost money. Is that the problem? (September 12, 2022).

The article can simply say: no, that’s not a problem, move on.

Instead, readers are subject to a string of fictional claims.

1. “The Bank of Canada is losing money, for the first time ever, because of emergency quantitative easing” – no, it’s not losing anything. Accounting simply records negative numbers for the same reasons as the RBA report above.

2. “Taxpayers are likely to hold the bag for years, ending up in billions of dollars — another nasty and unintended consequence of the COVID-19 economy.”

No taxpayer will pay anything to settle capital losses caused by Canadian banks.

3. Closer to home: “Losses do not interfere with monetary policy”.

In other words, it will not change the functional capacity of the bank.

If a private bank records these losses, it will be declared bankrupt unless it can restore its capital base.

The Bank of Canada has no such sense of urgency. It can operate at an accounting loss forever.

4. “However, time is ticking and losses are piling up” – the only clocks that may be ticking are old analog jobs that let bank employees know when it’s time for lunch or home!

Canadian banks do not have an accounting loss threshold beyond which an adverse event occurs.

The article launched an “economics professor” (who, of course, created the novel) who made a foreboding prediction — “We don’t currently know what this means for the loss of the federal government.”

hold on!

I think the Bank of Canada is suffering.

Ah, the professor admits that the central bank and the treasury are only part of the government.

At least we have.

The point is, despite all the pessimism and hunch about losses and the lack of a plan for how to pay them, the reality is simple.

Back to the left and right pockets.

Some accounting numbers will appear in each and everything will be fine.

in conclusion


Enough for today!

(c) Copyright 2022 William Mitchell. all rights reserved.

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