It’s Wednesday, and before we get into the music part, I’ve documented some developments in the banking system, there hasn’t been much coverage yet. I am referring to the fact that most central banks are now enforcing rate hikes that do more than just allow commercial banks to widen the spread between deposit and lending rates, which will generate huge windfall profits for the banks and their shareholders. Rising interest rates have also pumped cash into banks that hold reserve accounts at the central bank. Why? Because past quantitative easing programs have led to a massive accumulation of excess reserves, which are central bank liabilities. They are paying backstop returns on these reserves that are proportional to the rising policy target rate. So the big increase in payments has provided banks with a huge corporate welfare boost, while the same rise in interest rates has created hardship for borrowers, especially those on low incomes. And the amazing redistribution of income to the “champagne socialists” through our central bank.
Offsetting effect of interest on reserves
A few days ago, a friend from Europe sent me an interesting message.
With the ECB raising rates, it also means that commercial banks are now receiving a lot of “economic rent” due to the excess reserves created by the ECB’s quantitative easing program.
In the European system, the ECB provides trillions of euros in largesse to banks.
Consider the so-called need to squeeze overall liquidity by raising interest rates.
The scale of the redistribution of income to commercial bank shareholders and executives from those squeezed by inflationary pressures and rising interest rates is enormous.
In this article (September 23, 2022) – ECB seeks to cut subsidies to banks as rate hikes put them in trouble, sources say – The ECB has raised the backstop it pays for qualifying excess reserves “from -0.5% to 0.75% in less than two months,” we were told.
This leaves the ECB paying tens of billions of euros in interest each year on these reserves…
It also puts the ECB in the politically awkward position of subsidizing banks at a time when the public is struggling with high inflation.
Note that I removed the second half of the quote’s false statement that the ECB’s capital base is at risk.
For more on such shenanigans, see this blog post – The ECB can’t go bankrupt – get over it (May 11, 2012).
But the other point it makes is relevant.
This is a massive transfer of “public money” to banks and their shareholders, while the ECB is punishing borrowers (by raising interest rates).
The article pointed out that banks based on their borrowing from the European Central Bank—— Targeted Long-Term Refinancing Operations (TLTROs) – Provide banks with long-term financing on attractive terms, then retain these funds as excess reserves and profit from interest rate arbitrage.
The claim by the top body, the European Banking Federation, that there is nothing to see here is always a response from recipients of corporate benefits.
Since then, the ECB has responded to one of these issues, see – ECB reorients targeted lending operations to help restore price stability in the medium term.
These changes take effect today.
At the board meeting in October, the ECB raised interest rates to 0.75% and changed the current LTRO scheme (interest rate and repayment dates).
It also changes the support for the minimum reserve balances held by the ECB.
But as the chart below shows, the ECB is still saddled with huge liabilities in the form of excess reserves, which is just a reflection of the ECB’s massive asset purchases under various programs (APP, PEPP, ETC).
However, minimum reserve balances are only a small fraction of the total excess liquidity in the system, so any changes will have minimal impact.
As of September 2022, the excess reserve balance is 37747244.8 billion euros.
You can calculate the change in payment now flowing to the bank.
It’s a similar situation in Australia, where the RBA is paying banks a backstop rate slightly below the RBA’s cash rate target for any positive balances in so-called foreign exchange settlement accounts (essentially reserve accounts).
The RBA applies a formula to determine so-called “surplus” ESA balances.
The graph shows the history of ESA balances from June 1, 1994 to July 27, 2022.
What’s happening on the liability side is dovetailing with changes on the asset side, which almost correlates to the RBA’s government bond-buying program that started early in the pandemic in 2020.
This is the history of the RBA’s Australian dollar investments (nearly all government bonds) since 1 June 1994 (to 27 July 2022).
With the cash rate target raised from 0.10% on 6 April 2022 to 2.85% on 2 November 2022, the RBA is now making large cash payments each period to commercial banks and other financial institutions holding ESA balances, while Penalize low-income families with mortgages.
The problem, of course, is that if the RBA doesn’t pay back the ESA surplus balances, then it will have to consume them through other operations (such as selling government debt to banks) or lose control of them. The policy target rate due to competition among banks to shed excess funds.
But it is an example of how monetary policy decisions are not unbiased in their impact on income distribution and how they exacerbate income inequality.
Tomorrow, I will write further about how perverted monetary policy has become what it is, and why relying on it can lead to poor policymaking.
My European banking friends concluded that this was champagne socialism at its best.
It’s hard to disagree with this.
keep the child warm
I saw a tweet this morning suggesting that children in UK schools are being asked to wear ‘thermal underwear’ to school as the heat is switched off for most of the day as heating bills have more than doubled and the Ministry of Education Additional funding was declined.
I gave a talk today at a research and policy institute in Canberra (Australia) (from Kyoto, Japan) focusing on how Modern Monetary Theory (MMT) can help policymakers understand policy space more effectively.
The mainstream obsession with financial ratios surrounding fiscal policy – which is irrelevant in the context of a currency-issued government like Australia’s – distorts the kind of policy options envisaged and prompts policymakers to consider ultimately well below Anticipated Choices If those in positions of responsibility understood MMT more fully, they could choose to act.
In the case of the UK, the government has introduced “support wholesale prices” which they believe will be a six-month “price ceiling” (resource).
At issue, though, is that the support wasn’t large enough and didn’t last long enough, as evidenced by calls for children to dress a bit thicker.
The BBC quotes the chief executive of a private school offering trust near Oxford (resource):
I don’t want to be grandstanding, but this is about reducing heating time, and limiting heating is an option we must explore.
We haven’t decided what we have to do as a trust. But we may also have to require kids to wear coats in the classroom, as we have done in the age of Covid.
The darkest images of Charles Dickens come to mind.
The point is that while the government needs to be cautious about increasing spending when there is an inflation event on the train, even if it is primarily a supply-side event, there is little reason to tighten policy.
Financing school heating would not add pressure to existing price levels.
It could reward energy companies for profit fraud, which means the government could better deal with the problem directly through regulation and nationalization if need be.
But Britain’s future lies not in how much the government can reduce its deficit, but in how effectively its children can be educated in the formative years of their lives.
Sitting in a cold, austere classroom is unlikely to be the optimal learning environment.
The UK government cannot “save” money.
Saving is the behavior of financially constrained households who wish to expand their future consumption possibilities and must reduce current consumption to achieve this goal.
Currency issuers like the UK government issue government-issued currency, which never needs to be “stored”.
At times, it needs to withdraw some of its net spending to balance nominal spending growth with available production capacity.
But trying to slash school heating spending is not one of them, it only destroys the environment children need to fulfill their potential and become competent citizens as adults.
Today’s Music—All About the Watchtower
I haven’t been able to get this song out of my head lately. It resonates when I ride my bike, walk, run.
One of the classic songs.
i like the concept fight for change But I prefer what they make.
This is one of my favorite Jimi Hendrix songs (written by Bob Dylan) – along the watchtower.
Bob Dylan had this to say in his 1967 – John Wesley Harding album, I loved it at the time.
But a year later (1968), Jimi Hendrix, in his— Electric Paradise – I am obsessed with this song.
Electric Ladyland is still one of my favorite albums. I bought it in 1969 from the only imported record store in Melbourne (Bourke Street) (we always get albums late in Australia) run by musician Keith Glass whom I later met when I started playing professionally his city.
In the Playing for Change version, we see John Densmore popping up by the beach playing drums.
And Cyril and Ivan Neville and Ivan in Hammond.
And those Lakota singers and dancers.
And lead sitar break.
and Bizung family drums.
And percussion master Yu Hatakeyama.
It’s all happening.
This is what fighting for change does.
It is also sunny outside today.
This is the original by Jimi Hendrix.
It has original Rolling Stones member Brian Jones playing percussion.
Enough for today!
(c) Copyright 2022 William Mitchell. all rights reserved.