Friday, November 3, 2017

The Fed, ECB, BOJ and Bitcoin

Today I break from the Greek series for a brief post on Bitcoin and crypto-currencies in general.

A reader (Arnould, France) asked me what I think about the huge debt piling up on the books of Central Banks.

First, here are some charts to set the stage.

When Quantitative Easing (QE) went into high gear the balance sheet of the European Central Bank ballooned from 2.2 to 3.66 trillion Euro within just three years.  The largest portion, by far, is euro area securities that ECB has been buying on the open market (purple on the chart).

ECB Balance Sheet As Of End-2016

The Federal Reserve quadrupled its balance sheet to 4.5 trillion dollars after the Great Debt Bubble Implosion of 2008-10.  Almost all of its assets are US Treasurys.

FRB Balance Sheet As Of October 2017

The same pattern is evident in the Bank of Japan's balance sheet.  Again, the vast majority of the assets are JGBs (Japanese government bonds).
BOJ Balance Sheet As Of October 2017

The total assets of the three major central banks of the world come to almost 13 trillion USD, roughly equally shared among them (FRB 4.5, BOJ 4.4, ECB 4).  Now, I find this quite interesting... (Note  that global GDP is approximately 80 trillion USD.)

So, back to the reader's question: what are we to think of this enormous balloon of government debt  piled up in the books of the world's three largest central banks?  Is it going to crush us?  Can the world's largest economies bear this debt? Are they going to go bankrupt?

Well.... No, I don't think so.  Apart from the fact that interest rates are extremely low or even negative, which makes debt service almost an afterthought for governments' budgets, the key point here is that it is owed to... basically themselves.  Yes, yes... central banks are independent institutions, but they are NOT private sector entities.  It's not like they have depositors to think of.

So, here's a question: what would happen if one day all three of them announced in tandem that they are cancelling most government debt held in their books?  What would REALLY happen?  Basically... NOTHING.  And that's the beauty of it all.. abracadabra, now you see it, now you don't.  Debt gone at the push of three buttons.

Obviously, it would have to be all three central banks doing it together, otherwise the FX market would go completely nuts. And that's where the current craze for Bitcoin and other crypto-currencies comes in.

Bitcoin In USD

Yesterday, the Chicago Merc announced that it is looking into starting a futures market for Bitcoin... yeah, right.. obviously, the Merc is a profit seeking institution looking for business.  However, I'm not so sure that it should be creating an aura of legitimacy around this craze.

But, still... what is the "fundamental" reason for Bitcoin's stupendous rally?  My guess is that some people look at the three charts above and think that the world's main currencies are not all that solid. Perhaps, they may think, bitcoin is a safe haven like gold, but without the hassle .And it could ultimately be used as "regular" money to pay for goods and services.

As for myself, I think it's just another market bubble, driven by speculation, greed and a smidgen of flawed fundamentals.  Because, like I said above, what is to stop the three main central banks hooking themselves up in a three-way conference call (OK, the Chinese will be in the loop, too) and agreeing to cut their balance sheets by 75%?

The maxim: "Never Fight The Fed" is key here, and Bitcoin speculators should heed it.


  1. Interesting, thank you. So the central banks own the bonds that they have bought on the market, they are supposed to pay the interests to themselves, this is idiotic, and it would be easier to cancel them. No harm for anybody. Exactly as if I burnt some banknotes. Is it really as simple as that?

    Arnould, France

  2. Well... a nation's creditworthiness is reflected in its currency, most of all. For example, if the Fed decided to "cancel" the US Treasurys in its balance sheet unilaterally, i.e. without an identical move by ECB and BOJ for their holdings of European govt. and Japanese govt. bonds, the US dollar would plunge precipitously vs. the euro and the yen, and other currencies. Bye, bye reserve currency status.

    But if they all did it together... it would be feasible, yes.

    I don't think this has ever been done before, BTW so this is thinking out of the box.

    Central banks have always bought, held and sold government bonds as part of their monetary operations, of course. But this level of balance sheet ballooning is unprecedented, so I guess it would call for unprecedented actions, when it became necessary.

  3. Maybe central bankers had never thought about such a simple solution to their situation until you came with it a few days ago, who knows?

  4. ... and it was me, Arnould, still in France...