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Repeat after me: Central banks can make large losses and who would care

It’s Wednesday and I have a lot on today. I was scanning some transcripts from the European Parliament today as part of a project I am embarking on to update my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015). I have had lots of requests (including from publishers) to provide a revised version to take into account events since 2015, include Brexit and the pandemic. So my head is back in transcripts, hansard reports, and other official documents to create the trail of evidence I need to make the continued case against the monetary union and the EU, in general. I report today on a particularly interesting exchange that appeared in November 2020 in the European Parliament. And then we have some great harmonica playing.

For the record – central banks cannot go broke

There seems to be a regular furphy cycle – you know, the repeating rehearsal of fiction inspired by the lies that mainstream economists allow to run rampant in the broader community.

It is a familiar pattern – lie constructed, financial media takes it up, news explodes for a week, an Modern Monetary Theory (MMT) economist points out the fiction, and then some mainstream economist, suffering from attention deficit, tweets that they knew it all along and it is part of mainstream theory anyway.

Then someone points them to what the mainstream teach every day in university programs, or something these economists have written in the past (regularly) or said to the media, and there is some further Tweet about MMT being a cult etc.

For years we have been observing this pattern.

Recently, we have seen the recycling of the ‘central bank will make losses’ myth as part of the mainstream attack on the large bond-buying programs that have allowed government bond yields to remain very low if not negative.

On Monday (February 16, 2022), the European Parliament considered the – ECB Annual Report – which is a regular event that apparently serves as accountability.

On November 19, 2020, the President of the ECB, Madame Lagarde met with the Committee on Economic and Monetary Affairs of the European Parliament.

The – Transcript – of the hearing contains this interchange.

An Italian right-wing MP, Marco Zanni from the Lega Nord, who previously worked for an Italian investment bank. From 2019, Zanni represented the right-wing ‘Identity and Democracy’ group in the European Parliament.

He asked the ECB boss this question:

…. In the past days, someone included the President of the European Parliament in starting to discuss about the possibility to cancel in the future part of the debt purchased by the ECB under its PEPP programme … I would just like to know, technically, what would be the impact of debt cancellation on the ECB and in particular if the related losses could harm ECB capacity in pursuing its monetary policy goals – if it would risk bankruptcy or if a central bank runs under different rules compared to private banks or other private companies? Can you also explain how and why the ECB, as stated several times by the bank itself, can work also with a negative equity? Is the ECB in some way a special institution?

So it was about the issue that if the ECB (or any central bank) makes losses on any assets it holds, including the vast quantity of government bonds many central banks now have in their possession, are they able to continue with negative capital.

I have written detailed analyses of this question in these blog posts (many years ago):

1. The ECB cannot go broke – get over it (May 11, 2012).

2. The US Federal Reserve is on the brink of insolvency (not!) (November 18, 2010).

3. The consolidated government – treasury and central bank (August 20, 2010).

Most recently, I demonstrated that an Australian Broadcasting Commission ‘expert’ journalist was misleading readers by beating up a story that the RBA might go broke.

For that blog post – When ABC journalists mislead the public and spread fiction (January 13, 2022).

Anyway, Madame Lagarde answered the question by claiming that under Article 123 of the Treaty, the ECB could not write off the debt.

Zanni persisted:

I know, as I said, that there are limits in the Treaties, but it could happen in the future that, without formal cancellation of the debt, the ECB could incur losses related to its holdings under the asset purchase programme (APP). So I would like to know, technically, what would happen if those losses were to erode the equity of the ECB and how it is possible that the ECB could run also with negative equity.

Lagarde was then forced to the point of the question:

As the sole issuer of euro-denominated central bank money, the euro system will always be able to generate additional liquidity as needed. So by definition, it will neither go bankrupt nor run out of money. And in addition to that, any financial losses, should they occur, will not impair our ability to seek and maintain price stability. I’m afraid that it’s yet again a fairly simple, straightforward answer, but that’s the reality that we are dealing with, and I don’t speculate on alternative scenarios, because we have a treaty. We are the only issuer, and we are not at risk as a result.

Aside from the institutional references to the Treaty, that statement applies to all central banks that issue a sovereign currency.

They can never go broke and could operate without problems with permanent negative equity.

They are not profit-seeking companies owned by shareholders.

They are part of the currency-issuing governments (or in the special case of the ECB, the currency issuer in a system where the elected governments use the ECB’s currency).

So whenever you read a statement from a commentator that the central bank might make massive losses from its bond-buying programs, roll your eyes, and realise the commentator knows nothing about the topic.

Week 2 of our edX MOOC – Modern Monetary Theory: Economics for the 21st Century begins today

The second week’s material is now available in this 4-week free course. There is new material each Wednesday for the duration of the course.

Each week requires about 2 hours of participation for each student and so you can still catch up and enrolments are still open.

There is a large class undertaking the course so why not join them and learn about MMT properly with lots of videos, discussion, and more.

In the coming week, there will be the first of this year’s live interactive events, which adds to the material presented previously.

So even if you completed the course last year, these live events might be a reason for doing it again.

Further Details:

https://edx.org/course/modern-monetary-theory-economics-for-the-21st-century

If you want to do the course, get in early as then you avoid having to catch up.

All are welcome.

Music – Slim Harpo

This is what I have been listening to while working this morning.

It is from the incomparable – Slim Harpo – singing his class – Rainin in my heart, which was released in 1961 and reached Number 34 on the US hit charts.

He wrote the song with – Jerry West.

I first heard the song while I was still at high school when my brother brought home a record by – Pretty Things – which they had released in 1965.

My memory tells me that it was on an EP that I heard the song, but the song was also released on their second studio album of that year – Get Thre Picture?.

I loved their sound.

In the early 1970s, I sought out Slim Harpo and have listened to him ever since. Research in those days was more difficult (no Google) so I had to track records down at two shops in Melbourne (Keith Glass’s import shop in Bourke Street and Batman Records).

Slim Harpo had the usual life – early tragedy, hard manual work and then his talen was recognised.

He died young (heart attack) and the world lost a major talent.

The British R&B bands of the 1960s covered his songs, including Rolling Stones (I’m a King Bee), Yardbirds, Kinks, Dave Edmunds, Them, etc

Fabulous musician and song writer.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.

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    This Post Has 13 Comments
    1. Perhaps the title should have been ‘Governments can lose infinite amounts of money and who would care’.
      It’s relevant to the excitement about the amount of money wasted on PPE purchases in the UK.

      If the UK government spent money buying products and services that are not fit for purpose, it has wasted time and probably resources. But can one say it has wasted money when, as a currency creator, it has unlimited amounts of money? Saying it has wasted money suggests that there are now things that it will not be able to pay for because it now has less money. The fraudulent PPE sellers should be pursued, not because the state needs the money it paid them but because they should not be allowed to enjoy that money. The UK state never has less money. It always has an infinite amount of money. But it does have limited resources and time.

    2. Do you remember back in 2008, Banks were going bust with lending to equity ratios (capital and reserves) of 33 to 1 or more. No such problem for Central Banks funded by a sovereign currency issuing Treasury. Having to borrow inter-bank “reserves” to back excessive lending at ever higher interest rates; if you were considered credit worthy that is, brought the shutters down.

      As far as I can gather but not certain, the BoE balance sheet is at £1,100 billion with equity of £4.7 billion. A lending to equity ratio of circa 230. Would the BoE/Treasury (they are one and the same) worry if a few billion loan assets went bad; No. It might become politically embarrassing and all the usual suspects would be screaming printing money; government borrowing; national debt etc etc.

      Until the phrase “government borrowing” disappears from the dictionary, we are stuck with the lie that a government has to borrow its own created money, before it has any money to spend. The best example I have of smoke and mirrors accounting, is the UK Funding for Lending Scheme. A Gold medal candidate on how to camouflage a Treasury fiscal injection to look like a BoE monetary operation. You only have to read Appendix A. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2012/the-funding-for-lending-scheme.pdf?la=en&hash=57B13A5C9E94B5D02A451670C8B013DD22CF16EA

    3. In a recent assessment by the IMF to the Ukranian economy, corruption is considered to be the main underlying issue behind economic underdevelopment.
      I even saw a graph, ploting the estimated economic outcome of the Ukranian economy, if corruption lowered to EU average corruption level and another plot if corruption lowered to EU maximum corruption level.
      By EU standards, Ukraine would be a “paradise”, if corruption levels lowered to Hungarian practice.
      But, we know that the EU is a neoliberal contraption.
      And we know that neoliberalism was built on lies.
      They lied to the Italians.
      Italy was a big industrial power and is now dismantling it’s industries, replacing it by services, on the uber model.
      But, lying is corruption too.
      The Italian economic outcome of 2021, comes from corruption.
      So, maybe Ukranian corruption levels are not that high.
      Maybe the underdevelopment comes from somewhere else.
      Maybe, Ukrane is following the Italian model of development.
      Maybe the difference between Italy and Ukrane was the economic status of both countries at the outset – Italy was rich (maybe we can say, still is), and Ukrane was poor.
      Italy is becoming poorer and Ukrane even poorer.

    4. Acorn states his well-warranted belief that “until the phrase ‘government borrowing’ disappears from the dictionary, we are stuck with the lie that a government has to borrow its own created money, before it has any money to spend.” I would extend the thought to include the phrase “government spending” itself. Spending connotes, in the minds of many, a context of scarcity and depletion. So why doesn’t MMT drop the word and talk instead of government investment, government initiative, government support, etc.?

    5. Newton: That “borrowing” makes no sense for an entity that creates money out of thin air is something I rail on all the time. As I said in just the last post, Federal Government “borrowing” is nothing more than ex nihilo creation of money in the form of Treasury bonds.

      Treasury bonds, by the way, are an unnecessary anachronism under a non-convertible currency regime.

    6. Honestly, it’s amazing to me that the idea of government “borrowing” has lasted this long. That a government that creates its own money would then borrow it back for some reason doesn’t even pass the giggle test.

    7. “Repeat after me: Central banks can make large losses and who would care” It’s called a scheme…they want individuals to believe that the banks and companies are helpless and that we are the ones who should sacrifice ourselves to them. This is economic idolatry and needs to end.

    8. Please correct me. Surely issuing bonds is just a way of setting interest rates for those massive reserves of local currency held by foreign countries or by locals. When capital doesn’t want to borrow, the central bank offers to and so sets the borrowing rate. It’s all a bit of a throwback to Fort Knox and reminds me of the somewhat symbolic scene of Abbot and Costello? falling through a hole onto stacks of gold.

    9. David you are correct, selling bonds is a way to drain reserves out of the banking system with the goal of manipulating the prevailing interbank interest rate on the remaining reserves.

      An equivalent way to control the prevailing interbank interest rate is for the Central Bank to pay interest on reserves. The US Federal Reserve Bank is now doing that for excess reserves.

    10. Correct me if im wrong. Central bank can go with unlimited “losses” . But this losses can cause damage to the market especially if spent wastefully and therefore inflationary. On the other hand, it can improve markets if spent prudently and therefore deflationary.

      Printing money+ government investment with good returns= deflationary which allows for more money printing and government investment =improve markets

      Printing money+ government investment with bad returns= inflationary which disallows for more money printing and government investment= damage markets

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