Tuesday, September 27, 2022

Are Central Banks Bankrupt?

The title of today’s post is intentionally sensationalistic, chosen as a wake up call. With this proviso in mind, keep reading.

Central banks are.. banks (duh).  They have other duties and obligations as well, but their primary function is to borrow money by issuing promissory notes (currency) and to lend it when and if necessary, usually by accepting high grade bonds (Treasurys and mortgage-backed) as collateral. In some countries, like Japan and Switzerland, they even invest in equities, funds, etc. just like any other commercial or investment bank. And just like any other bank, the quality of their asset portfolio backs the solidity of their promissory notes, ie the currency they issue: dollars, euros, yen, etc.

Regular banks are prohibited from being overly exposed to one borrower, or one asset class. But central banks are mostly hemmed in: they have to lend to the State (they buy government bonds and issue currency) and, in the case of the US, to lend to the mortgage/property market.  Do normal credit parameters apply to central banks? They should, of course, but they don't - particularly during times of crisis when they step in as lenders of last resort.

But it's one thing to manage a transient crisis of liquidity in the banking system and quite another to monetize enormous amounts of government debt in order to then distribute it to one and all during the pandemic or other "emergencies" (helicopter money).  And how do you judge how much is too much?  As with any other bank, do a simple ratio: loans to turnover, or for central banks, balance sheet assets to GDP.

Here, then, is a chart of balance sheet assets to GDP for the Fed, ECB and Bank of Japan.  

  • BOJ is, by far, the most overexposed to government debt but there are some mitigating factors.  Chiefly, Japanese government debt is mostly domestically owned and the yen is not a major global reserve currency.  It's bad, but not as bad as it looks.
  • The ECB is definitely in trouble: it has to continue buying debt from the likes of Italy and Greece, countries that are, essentially, bankrupt if it weren't for the ECB's continued support. It's bad and, given internal friction between North-South in the EU, it's actually worse than it looks.
  • The Fed seems in fine shape, comparatively, but this is an illusion.  The dollar is the sole global reserve currency and cannot afford to be "watered down" by massive debt monetization, as has happen in the last three years.  
The chart goes a long way in explaining why the euro and the yen have collapsed vs the dollar in the foreign exchange market.  But, unless the Fed starts to rapidly shrink its balance sheet this will not last. The ECB is - finally - starting to talk tough on raising rates, even if it won't touch the subject of QT, particularly after Sunday's election results in Italy.

Bottom line: if the Fed, ECB and BOJ were regular commercial banks their regulators would be all over their case, accusing them of insane credit practices.  They aren't, but... if they keep going this way they will end up like the Reichsbank in the Weimar Republic. 


  1. the Weimar Republic's run away inflation was not caused by the central bank... it was caused by unstoppable expenditure, which forced the central bank to print endlessly...


    1. By H.
      Runaway inflation is ALWAYS caused by a central bank, one way or another, by hook or by crook. If the CB doesn't print the excess money there cannot be runaway inflation. Or any inflation at all..

    2. Funny how conservatives keep mum when massive corporate tax breaks, but are outraged when the people get a helping hand.

    3. and am I a conservative?... =)

      - I would say taxation is too high... but the bank bailouts were a really bad idea....

      - to Hell: when the govt spends recklessly, the CB has no choice but to print... sure, in theory they can not print......but in practise,... well,... the govt always finds a way to force them to do so...

    4. btw... in some southern Chinese slang, CB is the name for the female's privates... =)

    5. CB....China being an ancient society knows where the money is at ;)