Today’s edition of Fortune & Freedom is a little quote heavy. Because I’m not entirely sure you’d believe what I’ve got to say if I just say it myself. But before we get to the impending insolvency and bailout of central banks like the Bank of England and European Central Bank, let me ask you a question…
If you could print money (legally), could you go bust? Could you make losses so severe that the government is forced to bail you out?
If the very idea seems preposterous, you’re seriously underestimating the incompetence of civil servants.
You see, central banks around the world, including the Bank of England, are losing money. They may even go bust. And they’re already getting government bailouts too. The question now is whether any of it matters…
Which is intriguing in and of itself, right? Does the insolvency and government bailout of the most important monetary and financial institutions in the world, which single handily kept governments and stock markets afloat during Covid and the 2008 crisis, matter?
You’d think it’s obvious. So obvious, in fact, that only its leaders and government officials would deny it. For our own good, of course. To avoid a panic and all that.
And you’d be right.
First things first, though. Bloomberg explains the problem as it pertains to the European Central Bank, and why it’s the one in the news right now:
The euro area’s central banks will disclose their first significant losses from a decade of money printing in the coming weeks, heralding a new era of scrutiny and the prospect of taxpayer bailouts.
So central banks are losing money, big time. So bad they may even need taxpayer bailouts. A remarkable achievement for an institution that creates money. Here are some more details:
Even so, the ECB has criticized monetary shortfalls elsewhere in the European Union, and its own rules can require governments to fork out money for national central banks. It’s even feasible that the Frankfurt-based institution itself could need aid.
The Bundesbank will probably post small losses for 2022, rising to €26 billion ($28 billion) in 2023 if ECB rates stay at current levels, according to Daniel Gros, a board member of the Centre for European Policy Studies in Brussels.
That would wipe out the €20 billion of provisions for losses on asset purchase programs as well as its €5 billion of capital and reserves. For a normal company, that could mean insolvency.
Yikes. If the institutions that keep governments and stock markets afloat go bust, we must be in for a serious crisis, right?
Not so says Agustín Carstens, the general manager of the Bank of International Settlements, a sort of international central bank. Here’s his take from his speech on the topic:
Unlike businesses, central banks are designed to make money only in the most literal sense. They have a mandate to act in the public interest: to safeguard the value of the money they issue so that people can make financial decisions with confidence. The bottom line for central banks is not profit, but the public good.
Today, following an extraordinary period in economic history, some central banks are facing losses. This is particularly true if they bought assets such as bonds and other securities to stabilise their economies in response to recent crises. Many will not contribute to government coffers for years to come.
Does this mean that central banks are unsound? The answer is “no”. Losses do not jeopardise the vital role played by these institutions, which can and have operated effectively with losses and negative equity.
This is fair enough. Central banks are best thought of as operating outside of the economy. They push money in and out of the economy to manage inflation. What happens on their balance sheet and P&L statement needn’t matter.
But even Carstens couldn’t avoid mentioning that the coming insolvency of central banks does indeed matter a great deal after all. He uses a sleight of hand so shifty even I’m surprised.
Governments also have a role to play in the face of today’s central banks’ losses. Because these institutions are ultimately backed by the state, trust in money requires sound government finances and good financial management.
Losses matter because they may inflict a bruise on public finances […]
So his argument is that the insolvency of central banks doesn’t matter, but governments will bail them out anyway, which could matter a little.
Did you see the sleight of hand? If the insolvency of central banks doesn’t matter, why are governments bailing them out? And if the government bailout matters, then you can bet that the insolvency of central banks matters too. Especially given the state of government finances today.
It’s a bit like saying, “Don’t worry about Lehman Brothers. It’s just one bank.” Or arguing that Ireland can safely bail out its banking system without having to worry about a sovereign debt crisis. Or telling a child to ignore a bully. If you ignore the consequences of an action, it’s easy to claim it doesn’t matter. Until you get clobbered in the face by reality.
Carstens also implies that, to the extent that the government bailouts of central banks matters, it’s all the government’s fault. It’s their lack of “sound government finances and good financial management” that makes the bailout risky. It’s the government’s inability to manage their own budgets that has made the bailout of central banks a major issue.
But who has been busily financing government debt to unsustainable levels over the past decades? Central banks have, that’s who. And that’s why they’re facing such whopping losses on their vast government bond holdings.
It was central bank financing of government spending that gave us both the inflation and the unsustainable government debt that are now a problem for the central bank’s solvency. Central bankers are the perpetrator and the victim.
But this risk is as it should be, apparently:
Losses matter because they may inflict a bruise on public finances but a far greater injury would result from central banks neglecting their mandates in order to avoid a loss. The public, via elected officials, have given central banks the job of price and financial stability because of their enormous societal benefits. Now, and in the long term, the costs from central bank losses are insignificant compared to the costs of runaway inflation and prolonged economic crisis.
This is utter tripe. You only have to read the news to see that central banks are going bust while failing in spectacular fashion at their inflation mandate while governments struggle financially too. It’s not a trade-off, just a failure.
The ultimate irony in all this is the circle it has created.
Governments are bailing out central banks for losses that central banks incurred as a result of bailing out governments.
The institution that created vast amounts of money out of nothing in order to finance the government is being financed by the government.
Central banks are buying government bonds to save governments from going broke, and governments are sending the money to central banks to make sure they don’t go broke either.
No matter how you put it, it’s completely absurd and deluded. And if it gets worse, it could land both the government and the central bank broke together, with only each other to finance each other.
It’s also ironic if you think about it in terms of blame. The losses that threaten central bank solvency are the consequence of those government bonds being bought by the central bank to save the government. That same policy caused the inflation and higher interest rates that are pushing central banks into insolvency.
The same policy that finances the central bank’s rescue also creates the need for that rescue in the first place.
The real worry is that all these forces are self-reinforcing spirals. The more the government spends on central bank rescues, the more it gets into financial trouble. And the more it gets into financial trouble, the more the bonds on central bank balance sheets fall in value.
The more the bonds fall in value, the more the central bank gets into trouble too, increasing the size of the needed government bailout again.
The more the government gets into financial trouble, the more the central bank will have to buy government bonds to finance the government.
These downward spirals are how inflation gets out of hand, historically speaking. So I hope you’re not laughing.
Nick Hubble
Editor, Fortune & Freedom
