Started by PocketOption, Dec 03, 2022, 10:15 am
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Central banks are the ones who print money in an economy. So, they can’t run out of money, right? They just print more. If only central banking were that simple.
So, this is a little excursion into an obscure part of quantitative easing and interest rates that might show where the limits are for central banks to raise rates. And when they could start easing. Or, why what happened to the BOE back in September could happen to the rest of the world.
Central banks are, as the name implies, banks. They make money doing bank stuff, like loaning money, charging transactions and such. Not for common citizens, but for banks. That’s why central banks are often called “the bank of the banks”. The profits from central banks are then given to the respective Treasury of their country. But, if central banks lose money, then that goes in reverse: i.e., the government has to step in and “pay back” some of the profits.
Because of asset segregation. What’s that? It’s when banks keep their own assets separate from the assets of their customers. Banks have things that they own, like their buildings, and their own money; and they keep stuff or clients. Central banks do the same thing, except that their “clients” are banks. Central banks can’t just take money that belongs to their clients, but they also can’t just give themselves money.
Because it affects the credibility of the system, and their books won’t balance. But, more importantly, they don’t have to. If a central bank needs to spend money, it can do so with a promise to pay it back later. Since central banks are the lender of last resort, then their debt is as good as money. No need to print money, just issue debt.
Normally, everything goes fine. Except for one tiny detail: when issuing debt, you have to pay interest on it. Up until quite recently, central banks issued very little debt like this. And when they went on their buying spree after the subprime crisis, interest rates were really, really low. So, no need to worry.
But, they’ve been raising rates quite aggressively lately, meaning the amount of interest they have to pay is increasing. Particularly the Fed. The Fed bought a bunch of bonds, on which it receives profit in the form of interest payments. They also issued a bunch of debt, on which they make interest payments. The kicker is that the bonds have a fixed rate, while the Fed’s debt is variable rate. With a normal yield curve, the short-term, variable rate the Fed pays is less than the long-term fixed rate paid by the bonds. But now the yield curve is inverted, meaning that the Fed is losing money. $170B in losses so far.
Well, that’s the problem. The Dutch Central bank recently sent a letter to the Dutch Treasury warning that they might need to get some cash from the government to cover those losses. If the central bank tries to pay debt with more debt, then interest rates go even higher. Which is a problem for the central bank trying to set interest rates at a certain rate in order to fix policy.
So, yes, central banks could print money to solve this problem, but it would create another, worse problem. Governments are struggling to meet their payments as it is. With a recession, government income decreases, making finances even more tight. Especially in Europe, where governments have high levels of debt. If central banks then turn up needing billions to balance their books, and prevent a runaway spiral in interest rates like what happened in the UK last September, it could make the financial situation for governments extra difficult in the coming months.
The post Can Central Banks Go Bankrupt? The Perils of High Interest Rates After QE appeared first on Orbex Forex Trading Blog.
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