It's Wednesday, and as usual I scout around various issues that I have been thinking…
Central banks should just write off all their government debt holdings
The tensions in the public policy debate between economists is intensifying and on show in Europe, where these sort of obvious conflicts between adherence to dogma and a recognition that ‘out-the-box’ solutions are not only possible but preferred. More of these latter thought offerings are starting to appear as more people come to understand that the mainstream dogma has become more of a security blanket for reputations rather than saying anything about reality. One such proposal emerged last week in the form of a letter to the major European newspapers signed by more than 100 economists and politicians calling for the ECB to write-off its massive public debt holdings, which currently amount to around 25 per cent of total outstanding public debt. It is a good idea but some of the framing leaves a lot to be desired. At any rate, central banks everywhere should be buying up massive amounts of government debt and hitting the keyboard with zeros and writing it off. The world would be a much better place if they did that.
Historical Precedent
Around about this time, 68 years ago (February 27, 1953), the victorious nations from the Second World War formalised the – London Agreement on German External Debts – at a meeting in London.
The agreement covered:
… Germany’s pre-war public and private indebtedness and to the German debt arising out of post-war economic assistance …
That is, the deal excluded any reparations that might have been enforced as a result of Germany’s conduct during the War.
The amounts were staggering at the time:
1. 16.1 billion marks outstanding from the First World War settlement finalised at the Treaty of Versailles, which Germany had defaulted on in the inter-War period.
2. 16.2 billion marks owed to the US government for loans made to rebuild Germany after WW2.
The London Debt Conference was held between February and August 1952 and the offer of debt forgiveness was initially rejected by the German government.
The deal cut the outstanding debts in half and tied the repayment schedule to Germany’s subsequent export revenue, which reinforced the growing export-bias that then made it difficult to achieve currency stability in Europe given the growing trade imbalances that followed between European nations.
An recent article published in the European Review of Economic History (Vol 23, No 1, February 2019) – The economic consequences of the 1953 London Debt Agreement – studied the consequences of the Agreement and found that:
1. Germany’s immediate post WW2 growth was stunning given the circumstances.
2. The “debt relief program in 1953, known as the London Debt Agreement (LDA), might have partially contributed indirectly to growth by creating a propitious economics environment as well as directly by stabilising German public finances and allowing for greater public investment”.
Remember, this was during the early Bretton Woods period where fiscal policy was constrained by the need to manage the agreed exchange rate parities.
in more recent times, it was pointed out that one of the terms of the Agreement was that Germany would honour its reparation obligations arising from WW2 to Greece and that the current German government refused to acknowledge that obligation during the GFC.
Can a central bank cancel its holdings of debt?
Answer: Yes and it should.
I have long argued that after central banks purchase government debt either in the primary issue (less frequent now) or in the secondary markets they should just type a zero against the balance and write it off.
While there is all this pretence about central bank independence, the fact is that the central bank and the treasury functions are intertwined on a daily basis and both are parts of the currency-issuing government.
So when the central bank holds government debt it is just a left-pocket/right-pocket sort of situation.
In most situations, the central bank will receive interest payments from the treasury and then remit them back to Treasury in some form (dividends, etc) by arrangement within the government.
So a rather curious accounting charade with no significance for financial markets outside of the government (once the secondary bond market transactions are made).
Mainstream economists are horrified by this suggestion claiming it would be inflationary and would unleash a lack of discipline from Treasury departments.
They clearly misunderstand that the inflation risk, inasmuch as there is any in these current circumstances, is already in the system, the moment the deficit spending is exeecuted.
The fact that the central bank buys the debt, or, indeed, that the government issues the debt in the first place to match (or in the Eurozone Member State’s case to fund) the spending beyond tax drains, doesn’t alter that inflation risk.
So what happens to the government debt held by the central bank has no impact on the inflation propensity inherent in the spending.
The only question then is whether the spending was excessive in relation to the productive capacity of the nations and it would be far fetched to conclude that it was given the state of these economies and the excess capacity that is rife.
The question then is what would happen if the central banks around the world just wrote off all their holdings of government debt?
Answer: Nothing much at all.
They can still maintain liquidity management concerns using interest rate payments on excess reserves.
If they found themselves with ‘negative capital’, who cares. They are not corporations and do not have to be ‘solvent’ in the private corporate sense.
This is like comparing a household to a treasury (given that the central bank is part of the consolidated government sector).
See these blog posts (among others):
1. The consolidated government – treasury and central bank (August 20, 2010).
2. The ECB cannot go broke – get over it (May 11, 2012).
3. The US Federal Reserve is on the brink of insolvency (not!) (November 18, 2010).
4. Better off studying the mating habits of frogs (September 14, 2011).
Should the ECB cancel its public debt holdings?
Answer: obviously.
Last week over 100 economists and politicians published an ‘Open Letter’ in the leading European newspapers demanding that the ECB to cancel €2.5 trillion in debt it is holding.
That would wipe out around 25 per cent of the debt issued by EMU Member States.
The letter states in part (Source):
Citizens are discovering, some with much shock, that about 25% of the European debt is now held by their own central bank. In other words, we owe ourselves 25% of our debt and, if we are to reimburse that amount, we must find it elsewhere, either by borrowing it again to “roll the debt” instead of borrowing to invest, or by raising taxes, or by cutting spending.
Which is a statement that the EMU Member States in question do not enjoy currency sovereignty (using a foreign currency – the euro) and so are financially constrained.
Such a wedge is why a nation should never surrender their currency sovereignty.
The current proposal stated that the ECB could simply write the debt off and this would give the EMU nations renewed fiscal space to pursue a “green recovery” and “heal the severe social, cultural and economic damages undergone by our societies during the devastating covid-19 health crisis”.
I am supportive of the proposal but there are gaps in logic.
First, Brussels has already invoked the temporary emergency rules in the Treaty Annexe relating to the Stability and Growth Pact, which gives the Member States the latitude to engage in significant spending.
So there is no reason for Europe to be languishing in the state pointed out by the signatories to this proposal.
One reason they are languishing is that they have adopted the austerity mentality after years of being thrashed by the narratives and actions coming out of Brussels and they are scared stiff that the technocrats will get nasty soon and start raving on about the Excessive Deficit Mechanism procedure again.
Second, with the ECB purchasing significant proportions of the debt issued, such that bond yields are low and can stay low as long as the ECB wants, then the concerns of the proponents that the interest serving burdens will damage the prospects of recovery are somewhat exaggerated.
Sure, the ECB might turn on the Member States as it did during the GFC.
But it knows as well as anyone that insolvency is just a blink away for heavily-indebted nations in the Eurozone if bond yields rise quickly or significantly.
The ECB has to keep purchasing the debt or the monetary union will collapse.
Ironically, the Delors gang thought they could inflict their version of neoliberalism onto the Member States by producing a flawed architecture for the common currency but have produced a situation where the central bank that they thought could be bolted down is now exhibiting behaviour that is the anathema of these neoliberal pedants.
Third, none of this is to say that the proposal to cancel the debt is excellent.
The ECB, in fact, should ramp up the PEPP program to ensure it buys all the debt issued by the currency-using governments, which would maintain yields at zero levels and then simply write off the issue once purchased.
That would be the most desirable outcome.
I doubt that the politics of Europe could cope with Germany and the Frugal Four, at least being intolerant.
The Proposal thinks that their idea would be a “foundational” moment and pointed to the historical precedent made by the London Agreement (discussed above).
They think this would be an “extraordinary measure” to fit “extraordinary times.”
I agree the pandemic is an extraordinary time, but I would argue that progressives (which are represented by the proponents) should be ‘mainstreaming’ central bank debt cancellations.
It would only be ‘extraordinary’ if you think the appropriate benchmark was the mainstream taboo that central banks should not hold any public debt above the amount they might use to manage liquidity via open market operations.
I reject that benchmark.
The Modern Monetary Theory (MMT) benchmark is that the currency-issuing government has no need at all to line the pockets of bond investors by issuing corporate welfare in the form of the public debt.
In the Eurozone context, the situation is somewhat different given that the Member States surrendered currency sovereignty. So the MMT benchmark in that context would be that the ECB should just control all yields by purchasing the debt.
By avoiding the framing that a debt cancellation would be ‘extraordinary’ we can move the debate away from the neoliberal framing more quickly.
But the proponents clearly understand that:
1. “The ECB can without a doubt afford it. As many economists already recognize, even among those who oppose this solution, a central bank can operate with negative capital without difficulty.”
2. “It can even print money to compensate for these losses: this is provided for by the Protocol 4 annexed to the Treaty on the Functioning of the European Union.”
Once again framing and language here is a concern.
The way in which the ECB would restore its capital would be via some computer entries to its balance sheet. It alone can do that.
Protocol (No 4) on the statute of the European System of Central Banks and of the European Central Bank – is an annexe to the Treaty on European Union and to the Treaty on the Functioning of the European Union.
Chapter IV of the Protocol relates to the “Financial Provisions of the ESCB”.
Article 16 relates to “Banknotes” and says that “the Governing Council shall have the exclusive right to authorise the issue of euro banknotes within the Union. The ECB and the national central banks may issue such notes. The banknotes issued by the ECB and the national central banks shall be the only such notes to have the status of legal tender within the Union.”
Article 28 relates to the “Capital of the ECB”.
So in a situation that the ECB has negative capital, the Governing Council can authorise restoring that capital whenever it wants.
A commercial bank does not have that right. If its assets fail and they find they cannot cover their liabilities then they are insolvent unless they can inject more capital from private investors.
A central bank cannot become insolvent.
And remember that the euro is a fiat currency just like the US dollar or the Japanese yen, except that the governments involved use it rather than issue it.
The currency is not backed by any of value including the ECB’s assets.
It enters the eurosystem costlessly – keyboards typing numbers – and the IOU characteristic is only notional.
The ECB dealt with the question of insolvency in this Working Paper (No 392) – The Role of Central Bank Capital Revisited – way back in May 2004.
The authors noted that:
a central bank with a loss-making balance sheet structure would in this context still able to conduct its monetary policy in a responsible way, even with a negative long-term profitability outlook …
In practice, a central bank can never achieve an absolute, guaranteed institutional independence. In particular, no government can commit future governments (whether they obtain power by election, war, or revolution) not to change the central bank law or abolish its exclusive right to issue legal tender …
… central bank capital still does not seem to matter for monetary policy implementation, in essence because negative levels of capital do not represent any threat to the central bank being able to pay for whatever costs it has … Although losses may easily accumulate over a long period of time and lead to a huge negative capital, no reason emerges why this could affect the central bankís ability to control interest rates.
That should seal it.
The Proponents then ask whether this would be violating the “spirit of the treaty” and acknowledge that the ECBs conduct over many years in buying massive amounts of Member State debt has effectively already violated the prohibition on funding Member State deficits.
That is the point.
The EMU technocrats talk big on rules but violate them continually when it is convenient to maintain their positions.
Conclusion
I thought the most telling part of their letter was the following:
The European Union can no longer afford to be systematically impeded by its own rules. Other states in the world, such as China, Japan and the USA, are using their monetary policy tool to its full extent, i.e. in support of their fiscal policy.
The EU always impedes progress because of its rules.
Which is why Britain is lucky to be out of the mess.
And why, ultimately, the Treaties have to be scrapped and a new Europe based on intergovernmental agreements is created.
And, in doing so, the euro is scrapped and currency sovereignty restored. Then the newly sovereign states will cease being ‘Member States’ and can deal with the crises they face with the full currency capacity they lack now.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.
Signed by more than 100 letters- I think that is a typo in the first paragraph.
If the central bank cancels a govt debt it cancels its own asset. However, usually the govt owns the central bank so how does it make any net difference?
As you’ve said the difference is “nothing much at all”.
This situation is not the same in the EU/eurozone where the ownership of the ECB is shared so it does make a difference, at least to balance sheets, there.
Prof. Mitchell I have two questions: a) does the ECB governing council have the ability to write off its debt holding? and b) would they do that given that are appointees and only care about keeping a prestigious post, which several of them are not worthy having it?
Hi Bill,
I just cannot see the reason why the ecb should cancel its public debt holdings. As you wrote “when the central bank holds government debt it is just a left-pocket/right-pocket sort of situation”, so if the ecb cancel that debt nothing changes.
“The Modern Monetary Theory (MMT) benchmark is that the currency-issuing government has no need at all to line the pockets of bond investors by issuing corporate welfare in the form of the public debt.” Love it when Bill puts a radical political spin on MMT, despite it being merely a lens and all. Been reading a lot of quantum mechanics and the various theories that flow from it. Coming to the conclusion that MMT is a kind of QM of economics, mainstream economic thinking being Newtonian, engineering approximations (much more inaccurate than Newton’s), which break down upon closer analysis. In a sense, MMT “de-materializes” money, leaving us with resources as the repositories of value somewhat analogous to the “observations” left to us by QM. I know…resources are also “material” so the analogy only goes so far, but maybe there’s still a little something to ponder here.
The 13th Feb episode of ‘The Bottom Line’ on BBC Radio 4 dealt with this issue. About 10 minutes in Evan Davis asks his 2 contributors, John Kay and Minouche Shafik, whether the BOE debt ever has to be paid back. He refers with a nervous laugh to trendy MMT. Shafik, who came across as fairly clueless, appeared to suggest that it should be paid back even if it did not have to be paid back. Kay answered quite bluntly that it will never be paid back and that it was all just smoke and mirrors.
Kay also said that he had no problem with significantly higher national debt. But he attached importance to low interest rates. Which is surprising. One would imagine that Kay would know that the yield on government bonds is not controlled by the private sector.
Two comments:
1- Re “liquidity management”: normally I have understood this as the method the central bank uses to maintain the overnight interest rate. It drains reserves (“settlement balances” in Canada) from the interbank system when there is an excess due to a fiscal deficit (the usual case) or it supplies reserves in the instance of a government surplus (unusual for most countries).
However during the Covid crisis the Bank of Canada said it was engaging in “liquidity management” when it was in fact providing fiscal support to provinces that couldn’t find buyers for their bonds. In mid-2020 the province of Newfoundland came within weeks of being unable to meet payroll for its public workers. It asked for assistance from the federal government. Within a few days the Bank of Canada began purchasing its bonds directly. The expression was also used then Bank began purchasing government of Canada bonds as well although I think this was done via repurchase agreements (“repos”). Can these actions be called “liquidity management”? My assumption has been the expression in this case was used to hide the Bank’s true actions, i.e. fiscal support of governments.
2- Quantitive easing”: as per jv above, it seems to me if the Central Bank buys the (federal) government’s bonds and holds them to maturity this amounts to debt cancellation. The Treasury sells the bonds to the Central Bank, pays the interest on them to the Bank, and at the end of the year the Bank remits the payments to the government as its profits – the right pocket paying the left pocket. Of course this is pointless and no bonds should be issued in the first place but I do wonder if it is not more politically easy than outright cancellation. In Europe the interest payments would have to be remitted in the appropriate amounts to the countries whose bonds the ECB held.
Given how esoteric monetary operations are, almost all monetary issues are viewed by the public as strange magic. Very few understand quantitative easing but it seems to be accepted. But debt cancellation, everyone understands. Hundreds of comments to a recent Toronto Globe and Mail article by Konrad Yakabuski (Feb 11) demonstrate this.
Third comment: if the bonds are cancelled or none are issued to start with, the commercial banks will wind up with substantial assets, in the form of excess reserves, on their books. They will be unable to put them to use as they will remain trapped in the interbank system. After all one of the main results of bond issuance is to remove bonds from the interbank system. The excess reserves will sit on the banks’ books earning only the very small interest on reserves, indefinitely presumably if the offsetting bonds are cancelled (or not issued in the first place). This will be a drag on their profits.
Keith, the same has happened in Australia, the RBA has purchased a portion of state government debt due to the pandemic response. You are right that all these central bank opeations like QE are not well understood but have been accepted by the cental bank mandarins and the general public who have been systematically lied to about government debt ever since currencies became fiat. At least the MMT aware know what is really happening. Yes national and state government debts are being written off.
On the issue of bond issuance Bill and the leading MMT academics just recommend that this practice cease as it is just corporate welfare and that the cash rate be allowed to drop to zero or at most some negligable value as determined by low fixed interest reserve accounts held by the commercial banks and other financial institutions at the relevant central bank.
The rest of the EU less the ‘austerity four’ need to develop a countervailing choke hold on the neck of the ‘austerity four’ in regard to allowable trade surpluses within the EU. If the ‘austerity four’ neoliberal scrooges constrain fiscal policy then the rest of the EU must apply tariffs, quotas or other regulatory restrictions on imports from the ‘austerity four’ so that any austerity is justly distributed and all can collapse at an equal rate.
As Bill mentioned the EU structure is fundamentally flawed and a new union of independent European nations each with their own national currencies is the only long term sustainable path. Such a looser union could also eventually accept Russia, the CIS states and Turkey once minimum democratic, human rights and judicial standards are met and become a Eurasian Union as a counterbalance to the rising superpower in the Far East.
“normally I have understood this as the method the central bank uses to maintain the overnight interest rate. It drains reserves (“settlement balances” in Canada) from the interbank system when there is an excess due to a fiscal deficit (the usual case) or it supplies reserves in the instance of a government surplus (unusual for most countries).”
That method of maintaining overnight interest rates hasn’t been used since the GFC. Now we just pay interest on reserves to do that.
However there is still a huge operation to ensure that the amount of reserves in the system is maintained at a certain quantity and that government spending doesn’t add to them. Yet the whole interest on reserves concept renders the process meaningless.
Here is the accounting journal entry I would like to see for central banks:
Credit their holdings of government bonds (crediting this asset account reduces it) and debit a new asset account named “Investment in Society”. Credits and debits balance, so technicians are all happy — and there is no need to take any bookkeeping reduction in equity, which would just stir up unnecessary and irrelevant questions.
Thanks Bill, for taking up (I think) the theme from my comment on “When progressives remain regressive”. There are any number of so-called financial institutions that make billions from the buying and resale of government bonds. It is in none of their interests that any such “debt” be forgiven. And what I have not been able to get my head around is what might happen in global bond markets if such “forgiveness” were to be actually be practised. I suspect this is one of the reasons why MMT is being so strongly resisted – even by so-called economists. They think money is still actually worth something, and want to keep “making” it. And debt is the best and easiest way to make it.
But modern money is not worth anything. Try this: on a British banknote its says “I promise to pay the bearer on demand the sum of (say, ten) pounds”. So take your ten-pound note to the Bank of England and demand that they fulfill their obligation. “Of course, sir” says the BoE teller; and hands you two five-pound notes – each of which says “I promise to pay the bearer on demand the sum of five pounds”.
Some answers, or at least some insights, into some of the comments and questions in this thread about the Eu and the ECB would, I think, be informed by reading “Adults in the Room” by Yanis Varoufakis; the Finance Minister of Greece during the “Grexit” crisis of 2015 (ISBN 9781784705763).
And yes Bill, Britain is lucky to be out of the mess!
re Neil Wilson: “However there is still a huge operation to ensure that the amount of reserves in the system is maintained at a certain quantity and that government spending doesn’t add to them. Yet the whole interest on reserves concept renders the process meaningless.”
Meaningless indeed! I understand from what you write that rather than have the Central Bank buy all the new bonds the government is allowing some to be sold to banks and dealers. Pointless for maintaining the overnight interest rate clearly since there is a vast excess of reserves in the interbank system. So what is the point? To provide income via fees to banks and dealers, I guess?
I suppose I should take a look at the current details of the Bank of Canada (BoC) and commercial bank balance sheets. I have looked at the BoC numbers. Some $200 billion of bonds and repos have been added to its balance sheet since the start of Covid. However I have not tried to figure out how much bond issuance there has been nor what is winding up on the balance sheets of the banks as excess settlement balances (“reserves” in countries other than Canada).
You are forgetting that in a fiat currency system the Central Bank and the currency issuing Treasury are one and the same. The Central Bank has a conventional balance sheet, assets have to equal liabilities. The currency issuing Treasury has no such equivalent and in reality runs with an unbalance sheet. The unbalance has no consequence for the Treasury.
Both exist in two different accounting systems where Treasury securities don’t appear on the Central Bank’s balance sheet, until they are swapped back into the “reserves” (government spending) that bought them originally, that is, previously created Treasury money units.
jv writes: “I just cannot see the reason why the ecb should cancel its public debt holdings.”
To educate the public that it can be done? ..and hence also demonstrate politicians’ talk of a need for ‘austerity’ to pay back government covid-rescue debt, is nonsensical.
@Jv and @’Neil Halliday’ there really is no such thing as a CB cancelling it’s public debt holdings. It’s just numbers on a spreadsheet, it’s not really “holding” anything. It is not even “left-pocket paying right-pocket” stuff, since there is nothing like a “payment” going on, it’s just an accounting record. When CB debt “holdings” are given interest payments from Treasury it is a charade, there is zero need for that increment in digits on the spreadsheet (which is the left-pocket transferring digits to the right-pocket), it serves no useful purpose and is entirely perfunctory.
When the accounting record number is typed over by a “0.00” it is not really a debt cancellation, it is an accounting record reset, nothing more. You can choose to call it “debt cancellation” if you like to think you can be in debt to yourself in your own IOU’s. But if you ask me that is a distortion of language. (The framing here is MMT: that central banks are branches of a consolidated government.)
A debt is something that implies by logical necessity a corresponding equal credit, something to be redeemed, the Treasury owes nothing real to the CB other than just the promise to type in some numbers on the account spreadsheet, you cannot seriously call that a real debt/credit arrangement by common language meaning, although everyone without an MMT understanding does!
Nerds with backup disks will probably maintain the historic account records of CB debt, for some purely academic purposes, but that’s the only purpose, forensic historical analysis.
By the way: something similar in terms of a reset happens every few years in Time & Frequency Standard metrology, the world atomic clock system gets dialed back a bit, manually, to adjust the nominal year to the astronomical year. No one loses any time when those resets occur, like CB debt, the atomic clock NTP time is nominal not real, (we could make it whatever number we want with world standardized in sync via UTC to keep train and plane schedules un-disrupted).
Bijou Smith writes:
“there really is no such thing as a CB cancelling it’s public debt holdings”.
OK, but the task at hand is to educate the public that sovereign currency-issuing government doesn’t need to tax or borrow, in order to spend.