It's Wednesday and I have comments on a few items today. I haven't been able…
It’s Wednesday, and before we get to the music segment, I document some developments in the banking system which are not receiving much press at the moment. I refer to the fact that the rate hikes now being implemented by most central banks are not just allowing the commercial banks to widen spreads between deposit and lending rates which will generate significant windfall profits for the banks and their shareholders. The increasing interest rates are also delivering massive cash injections to the banks who hold reserve accounts at the central banks. Why? Because the quantitative easing programs from the past have resulted in a massive buildup of excess reserves which are liabilities for the central banks. They are paying support returns on those reserve, which are scaled against the rising policy target rates. So the payments have escalated significantly and delivering a massive corporate welfare boost to the banks while the same interest rate rises are causing hardship to borrowers, especially those on low incomes. And amazing redistribution of income towards the ‘champagne socialists’ all via our central banks.
The counteracting impact of interest on reserves
A friend from Europe sent me an interesting snippet of information the other day.
As the ECB hikes interest rates, this also means that the commercial banks are now receiving massive ‘economic rents’ because of the excess reserves that were created by the ECB’s quantitative easing program.
In the European system that amounts to trillions of euros of largesse that the banks are being given by the ECB.
Think about that in relation to the alleged need to squeeze overall liquidity via the interest rate hikes.
The redistribution of income from those squeezed by the inflationary pressures and the interest rate increases to the shareholders and executives of the commercial banks is massive.
In this article (September 23, 2022) – ECB seeks to cut subsidy to banks as rate hikes leave it on hook, sources say – we learn that the ECB has lifted the support rate it pays on the qualifying excess reserves “from -0.5 per cent to 0.75 per cent in less than two months”.
This leaves the ECB on the hook for tens of billions of euros in annual interest on those reserves …
It also puts the ECB in the politically uncomfortable position of subsidising banks at a time when the public is struggling amid high inflation.
Note, that I deleted the second half of the first sentence in that quote that made spurious claims about the capital base of the ECB being threatened.
Please refer to this blog post for more information about that sort of ruse – The ECB cannot go broke – get over it (May 11, 2012).
But the other point it makes is relevant.
This is a huge transfer of ‘public money’ to banks and their shareholders while in the same act (hiking rates) the ECB is punishing borrowers.
The article notes that banks are borrowing from the ECB under its – Targeted longer-term refinancing operations (TLTROs) – which offered “banks long-term funding at attractive conditions” and then retaining those funds as excess reserves and profiting from the interest rate arbitrage.
The peak body European Banking Federation claimed there was nothing to see here, which is always the response from corporate welfare recipients.
Since then, the ECB has responded to one of the issues, see – ECB recalibrates targeted lending operations to help restore price stability over the medium term.
Those changes take effect today.
At its October Board meeting, the ECB raised interest rates to 0.75 per cent and changed the current LTRO scheme (rates and repayment dates).
It also changed the support rate on minimum reserve balances held at the ECB.
But it still remains that the ECB is carrying a massive liability in the form of excess reserves as shown in the following graph, which is just a reflection of the massive asset-buying that the ECB has been engaged in under various programs (APP, PEPP, etc).
The minimum reserve balances though are a fraction of the total excess liquidity in the system so any changes will have minimal impact.
As at September 2022, there were 3,774,724.48 million euros of excess reserves outstanding.
You can do the calculation of the change in payments that are now flowing to the banks.
A similar situation has arisen in Australia where the RBA pays the banks a support rate just below the RBA’s cash rate target on any positive balances in the so-called Exchange Settlement Accounts (which are basically the reserve accounts).
There is a formula that the RBA applies to determine so-called ‘surplus’ ESA balances.
This graph shows the history of the ESA balances since June 1, 1994 up until July 27, 2022.
That picture on the liability side is matched by the shifts on the asset side that is almost all to do with the RBA’s government bond-buying program that commenced in the early days of the pandemic in 2020.
Here is the history of the RBA Australian dollar investments (almost all government bonds) since June 1, 1994 (to July 27, 2022).
With the cash rate target rising from 0.10 per cent on April 6, 2022 to 2.85 per cent on November 2, 2022, the RBA is now paying the commercial banks and other financial institutions who hold ESA balances with it a massive amount of cash each period, while punishing the low-income families who have mortgage debt.
The problem, of course, is that if the RBA didn’t pay the support rate on the surplus ESA balances then it would have to drain them using other operations (for example, selling government debt to the banks) or otherwise lose control of their policy target rate, as a result of the competition that would emerge between the banks to rid themselves of their excess funds.
But this is an example of how monetary policy decisions are not unbiased in terms of their impacts on income distribution and how they worsen income inequality.
Tomorrow, I will write further on how perverted monetary policy has become and why a reliance on it leads to poor policy making.
My European banking friend concluded this was Champagne Socialism at its best.
Hard to disagree with that.
Keeping children warm
I saw a Tweet this morning that indicated that children in British schools are being asked to wear “thermal underwear” to school because the schools are turning off heating for most of the day as heating bills more than double and the Department of Education has declined to provide supplementary funding.
I gave a presentation today to a research and policy intitute in Canberra (Australia) (from Kyoto, Japan) which focused on how Modern Monetary Theory (MMT) can help policy makers understand the policy space more effectively.
The mainstream obsession with financial ratios surround fiscal policy – which are irrelevant in the context of a currency-issuing government like Australia – distorts the sort of policy options that are conceived and moves policy makers to consider options that ultimately are vastly inferior to what would be a chosen action if MMT was understood more fully by those in these positions of responsibility.
In the case of the UK, the government introduced a ‘supported wholesale price’, which they considered would become a ‘price cap’ for six months (Source).
The contention though, is that the scale and duration of the support is inadequate as is indicated by the call for children to clothe themselves more thickly.
One CEO of a private school providing trust around Oxford was quoted by the BBC as saying (Source):
I don’t want to be sensationalist but it’s about reducing the time the heating is on, restricting the heating is an option we have to explore.
We haven’t as a trust decided yet what we have to do. But we might have to ask children to wear their coats in classrooms too, like we did in Covid times.
Charles Dickens’ most gloomy images come to mind.
The point is that while governments need to be careful in relation to spending increases when there is an inflationary episode in train, even if it is largely a supply-side event, there is no reason for austerity.
Funding the schools for adequate heating will not add pressure to the existing price level dynamics.
It might reward profit gouging from energy companies, which means the government would be better placed dealing with that directly through regulation and nationalisation if required.
But the future of Britain lies not in whether the government reduces the deficit by some amount, but, rather in how much education its children can effectively receive in the formative years of their lives.
Sitting in cold, austere classrooms is unlikely to be an optimal learning environment.
The British government cannot ‘save’ money.
Saving is the act of financially-constrained households who desire to expand their future consumption possibilities and must reduce their current consumption in order to achieve that goal.
A currency-issuing government such as the British government issues the currency and never needs to ‘save it up’.
Occassionally it will need to withdraw some of its net spending to balance nominal spending growth with available productive capacity.
But trying to cut spending on school heating is not one of those cases and just undermines the environment that its children need to achieve their potential and become functioning citizens into their adult years.
Music for today – All Along the Watchtower
I have not been able to get this song out of my head recently. While riding my bike, walking, running, whatever, it resonates.
One of the classic songs.
I love the concept of Playing for Change but I like what they produce even more.
It is one my favourite Jimi Hendrix songs (written by Bob Dylan) – All Along the Watchtower.
Bob Dylan put it out on his 1967 – John Wesley Harding album and I liked it then.
But then when Jimi Hendrix put it out a year later (1968) on his – Electric Ladyland – I was mesmerised by the song.
Electric Ladyland remains one of my favourite all-time albums. I purchased it in 1969 (we always got albums on delay in Australia) from the only import record shop in Melbourne (Bourke Street), which was run by a musician Keith Glass, who I subsequently got to know when I starting playing professionally around the city.
On the Playing for Change version, we see that John Densmore pops up playing drums by the beach.
And Cyril and Ivan Neville with Ivan on the Hammond.
And those Lakota Singers and Dancers.
And the lead Sitar break.
And the Bizung Family Drums.
And master percussionist Yu Hatakeyama.
It is just all happening.
And that is what Playing for Change does.
And the sun is shining outside too, today.
And here is the original Jimi Hendrix version.
It has original Rolling Stones member, Brian Jones, playing percussion.
That is enough for today!
(c) Copyright 2022 William Mitchell. All Rights Reserved.