British House of Lords inquiry into the Bank of England’s performance is a confusing array of contrary notions
On November 27, 2023, the Economic Affairs Committee of the British House of Lords completed…
The global press is full of stories lately about how central banks are taking big losses and risking solvency and then analysing the dire consequences of government bailouts of the said banks. All preposterous nonsense of course. It would be like daily news stories about the threat of ships falling off the edge of the earth. But then we know better than that. But in the economic commentariat there are plenty of flat earthers for sure. Some day, humanity (if it survives) will look back on this period and wonder how their predecessors could have been so ignorant of basic logic and facts. What a stupid bunch those 2022 humans really were.
I have previously considered this topic:
1. The ECB cannot go broke – get over it (May 11, 2012).
2. The sham of ECB independence (October 24, 2017).
3. Repeat after me: Central banks can make large losses and who would care (February 16, 2022).
4. Central banks should just write off all their government debt holdings (February 15, 2021).
5. Banque de France should write off its holdings of State debt (April 24, 2019).
6. The US Federal Reserve is on the brink of insolvency (not!) (November 18, 2010).
7. Better off studying the mating habits of frogs (September 14, 2011).
The Reserve Bank of Australia released its – Review of the Bond Purchase Program (published September 21, 2022) – which reported that the RBA purchased:
… a total of $281 billion of Australian, state and territory government bonds between November 2020 and February 2022.
That is most of the debt that was issued in that time period.
They concluded that the action “lowered the whole structure of interest rates in Australia, and supported confidence in the economy in the face of serious downside risks.”
The review provided this graphic to show the scale of these bond-buying programs around the world.
It is hard not to conclude that the programs were ‘massive’ in relation to the debt issued and the size of the economies.
It also puts the claims that public debt ratios are rising above acceptable solvency levels into perspective.
First, this is debt that the government effectively has issued to itself. Left pocket-right pocket sort of gymnastics.
Second, the right pocket will always be able to pay the left pocket back and the left pocket will then remit the payments above costs back to the right pocket.
The Review also rejects the claims that the QE program conducted by the RBA has caused or exacerbated the current inflationary episode.
They show that the so-called ‘quantity theory of money’, used by Monetarists etc, is not functional because “there has not been a stable relationship between monetary aggregates and economic activity or inflation in Australia for several decades”.
1. The velocity of circulation “has declined over time, falling sharply during 2020” – which means that the money stock has been turning over more slowly in transactions.
2. “Moreover, different components of the money supply can move independently over time. While the BPP led to a sharp increase in ES balances and thus ‘base’ money, the increase in the broader money supply, which is relevant for nominal expenditure in the economy, was not as large”.
So the QTM cannot be used as a framework for explaining the current inflation – exit Monetarism and the rest of Milton Friedman’s fictions.
What has agitated the media is the following statement:
For the RBA, the purchased bonds pay a fixed return, while the interest paid on the Exchange Settlement (ES) balances created to pay for the bonds varies with monetary policy settings. As interest rates increase there is a financial cost to the RBA from this. The ultimate cost will be known only once the last of the purchased bonds matures in 2033, with various scenarios presented in this review. Under most scenarios, the Bank will not be in a position to pay dividends to the government for a number of years.
The ES balances are what Americans call bank reserves.
The bond-buying programs just swapped assets – bonds from the bond-holders and reserves to their bank accounts.
The question that the press then pursued was the implications of this ‘financial cost’.
This is the sum of known returns – the yields on the bonds and face value – the unknown costs, which relate to the interest paid on ES balances that are sensitive to future monetary policy movements.
The RBA estimates that
Overall, the cumulative financial cost of the program to the Bank over the period to 2033 is $35 billion, $42 billion, $50 billion and $58 billion under the scenarios from lowest to highest ES rate path.
Wow, that sounds bad.
The press certainly think so.
The BBC report (September 21, 2022) on the Review carried lurid headlines – Covid: Reserve Bank of Australia takes $30bn hit on bond purchases.
That is, if you don’t understand things.
Importantly, the RBA notes that:
The Reserve Bank Board considered whether to seek a government indemnity for the BPP, but decided it was not necessary. The Board recognised that an indemnity would insulate the Bank’s balance sheet from the effects of the BPP, but it would have no effect on the overall public sector balance sheet; the impact of the BPP would simply be transferred from the Bank’s balance sheet to the government’s balance sheet.
Left pocket and right pocket.
The Deputy Governor of the RBA, Michele Bullock gave a presentation in Sydney on the – Speech: Review of the Bond Purchase Program.
She specifically homed in on the erroneous claims about the RBA making losses and outlined how the accounting losses are treated.
She noted that all discussions about RBA capital reserves are made in consultation with the Federal Treasurer – left and right pocket.
It is “the Treasurer” who “determines” how much of any positive earnings the RBA makes on trading go into the capital reserves and the amount that goes into the Treasury account as ‘dividends’.
And accounting losses are subtracted from the capital reserves
So in the financial year 2021/22, the RBA recorded:
… an accounting loss of $36.7 billion …
The implications are that the RBA made a loss bigger than current reserves (by $21 billion), which the Deputy Governor said:
… means that the Bank has negative equity.
Is that a problem?
Not at all.
The Deputy governor told us why:
If any commercial entity had negative equity, assets would be insufficient to meet liabilities and therefore the company would not be a going concern. But central banks are not like commercial entities. Unlike a normal business, there are no going concern issues with a central bank in a country like Australia. Under the Reserve Bank Act, the government provides a guarantee against the liabilities of the Reserve Bank. Furthermore, since it has the ability to create money, the Bank can continue to meet its obligations as they become due and so it is not insolvent. The negative equity position will, therefore, not affect the ability of the Reserve Bank to do its job.
Therefore no issue.
End of story.
The current Treasurer has apparently agreed to forego ‘dividends’ so that future RBA ‘profits’ will just restore the accounting capital but as the Deputy Governor admitted:
… the Bank can continue to operate with negative equity …
Forever, it is wanted to without any loss of capacity or function.
But it seems that journalists around the world don’t understand the reality.
For example, the Toronto Star newspaper ran a story by its economics expert (one might say alleged expert once you read the article) – The Bank of Canada, for the first time in history, is losing money. Is that a problem? (September 12, 2022).
The article could have simply said: No, it is not a problem and the moved on.
Instead, the readers were subjected to a litany of fictional claims.
1. “Canada’s central bank is losing money, in the red for the first time ever, because of the emergency quantitative easing measures” – no, it is not losing anything. An accounting is just recording a negative number for the same reasons the RBA reported above.
2. “Taxpayers could very well end up holding the bag for a couple of years, to the eventual tune of some billions of dollars – another nasty and unintended consequence of the COVID-19 economy.”
No taxpayer will be paying anything to address the capital loss made by the Bank of Canada.
3. Then to the point: “the losses won’t interfere with monetary policy”.
That is, won’t alter the functional capacity of the bank.
If a private bank recorded these losses it would be declared insolvent unless it could restore its capital base.
The Bank of Canada has no such urgency. It can operate at an accounting loss forever.
4. “The clock is ticking, however, and the losses are piling up” – the only clocks that might be ticking are old analogue jobs that allow the Bank’s employees to know when it is time for a lunchbreak or to go home!
There is no threshold of accounting losses beyond which something bad happens at the Bank of Canada.
The article wheeled out an “economics professor” (of course, they create the fictions) who made predictions laced with forebodings – “We don’t currently know exactly what this will mean for the federal government’s losses.”
I thought the Bank of Canada was making the losses.
Aah, the professor is admitting that the central bank and the treasury are just part of government.
At least we have that.
The point is that despite all the gloom and forebodings about losses and lack of plans about how to pay for them, the reality is simple.
Back to left pocket and right pocket.
Some accounting numbers will appear in each, respectively and all will be well.
That is enough for today!
(c) Copyright 2022 William Mitchell. All Rights Reserved.