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The coin the central bank issues is a liability in its balance sheet. If it prints 1 trillion, uses it to buy 1 trillion worth of commercial paper and those ass
by manholio 4y ago
The coin the central bank issues is a liability in its balance sheet. If it prints 1 trillion, uses it to buy 1 trillion worth of commercial paper and those assets lose 10%, then the bank has liabilities worth 1 trillion (outstanding currency) but only 900 billion in assets to cover them. Technically in default, but also in a very special economic position, because no body expects the central bank to ever cover its full liabilities.
- lottin 4y agoCentral bank reserves are not a liability because they don't entail a financial obligation. They're only listed as a liability on the balance sheet because it's convenient from an accounting perspective. When a central bank buys a bond, they use reserves, which are not a liability in a financial sense, therefore the central bank makes an instant profit. Even if the bond were to lose 80% of its value, the central bank would still make a 20% profit. Bankrupting a central bank is a lot harder than you think.
- manholio 4y agoIt's not just "accounting convenience" it's literally the way the profit vs loss of the central bank is defined. The central bank typically has a legal obligation to maintain stable prices, so while outstanding currency is not a liability in the conventional sense with a certain maturity date, interest etc., it's undoubtedly a debt towards society at large, which could presumably need to be redeemed and sterilized in the course of monetary policy, at least in part. Outstanding currency is a perpetual zero interest loan towards the central bank by the holders of currency. If a central bank loses 80% of its real reserves, and financial circumstances arise where it must repurchase more than 20% of it's issued currency, for example to defend the exchange rate against a capital flight, than the bank is effectively "bankrupt" - it can no longer fulfill its legal role and regulate the value of the national currency. It's not a traditional bankruptcy, but it's a de-facto failure which many central banks experienced.
- lottin 4y agoYou're stretching the meaning of 'debt' and 'bankruptcy' beyond what these words are generally accepted to mean.
- manholio 4y agoSince the central bank controls the unit of account value and can always devalue and print itself out of any sticky situation, the only meaningful way it can go "bankrupt" is to lose the ability to appreciate the currency. I agree it's a stretch. The notion that the central bank can conjure pure profits out of thin air and has no liability against its issued currency is fantastical, it would suggest a perpetual profit machine. In reality, any issued currency comes with a strong liability to buy it back in inflationary times, so it's clearly an external debt from the CB's perspective, this is a well established notion. This has origin in the pre-modern, free banking era, where competing private banks issued "bank notes" attesting their demand deposits, and which in time became widely accepted. This is basically the exact thing a central bank does, with a state granted monopoly, and no link to the gold and silver the bank "owes" for the notes.
- lottin 4y agoSorry, I can't agree that there's some unspoken promise, or even a faint expectation, that that the central bank will buy its own currency back. This is simply not true.
- manholio 4y agoBuy back is implicit in the price stability mission any central bank has; it cannot be fulfilled without controlling the supply of currency in the economy, i.e (at least) limited buyback. Without that, what you get is something very much like a cryptocurrency in terms of volatility.
- lottin 4y agoThere is no implicit promise of buying back their own coins. This is ridiculous.