A Run on Central Banks?

June 3, 2010

The latest phase of the global credit crisis, which has thrust Europe into the center of investors’ concerns, raises questions about the ability of central banks around the world to continue bailing out the financial sector open-endedly. Already, the turmoil has forced a policy about-face by the European Central Bank as it resorts to making direct purchases of sovereign debt in the same way that the U.S. Federal Reserve took on Treasuries and piles of battered mortgage bonds in an effort to stem America’s historic housing crash.

The string of emergency rescues led by global central banks was certainly popular among the banks – hardly surprising considering their continued existence was at stake. But now, bankers are bemoaning the very deficits incurred by various national governments in part because of financial sector bailouts. They worry all of the commitments made in Europe and the United States might have put governments – and perhaps even the central banks themselves – on the path to insolvency. Of course, central banks can’t really become insolvent in a strict sense, since they can always print money. The anxiety then becomes the ability of the monetary authorities to tighten their purse strings in time to prevent spikes in inflation and interest rates. This is how Joachim Fels at Morgan Stanley puts it in a research note to clients:

The longer the banking crisis and the sovereign crisis last (and both are by far not over yet), the more likely we will get a crisis of confidence in the central banks who act as lenders of last resort to banks and governments. Financial and fiscal stability concerns will make it difficult for central banks to aggressively fight inflation pressures once they emerge. Inflation in the U.S. and the euro area is still low, but the UK, where inflation is way above target, may be a leading indicator rather than an aberration. The ECB is just the latest victim – the sovereign and banking crises have forced it into actions that threaten to undermine its credibility over time. The gold price and exchange rates have already been signaling a loss of (overall and relative) confidence in the value of fiat money for some time. Yet, the famed bond vigilantes are fast asleep, lulled in by liquidity, carry and roll-down.

Yes, central banks can extend unlimited amounts of credit to banks and governments. But they do so by issuing ever more of their own liabilities – money. And just as the trust in banks’ and governments’ liabilities eroded when they issued ever more, we believe that the trust in money will erode if central banks issue ever more of it.

The line of thinking harkens back to something Willem Buiter, a former member of the Bank of England’s Monetary Policy Committee who now teaches at the London School of Economics, wrote back in May 2008, when the global financial crisis was still gathering steam. In the piece, entitled “Can Central Banks Go Broke?”, Buiter, argued that central banks could indeed go broke but that this was most likely to happen in developing countries, where the bulk of debt obligations are denominated in a foreign currency (and therefore cannot be inflated away via growth in the money supply).

Central banks can go broke and have done so historically, albeit mainly in developing countries. Central bank insolvency may become an issue again, even in advanced industrial countries, if central banks were to assume too many foreign-currency denominated liabilities in an attempt to support or bail out private banks and other financial institutions deemed to be too large or too interconnected to fail.”

The Fed’s foreign exchange swaps don’t quite fit that category yet, but they sure seem like a step in that direction.


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Indeed, central banks do go broke; indeed, governments can print money; indeed printing inordinate amounts of money (monetization) is the root cause of inflation. If this is all true, why dont all governments inflate their way out of debt and deflate ? Because they will destroy the bond markets that they require to sell more of their own bonds and securities. Thats why we eventually get deflation; not because governments want it, but because it becomes the least of all evils, hyperinflation included.

Posted by nwfreetrader | Report as abusive

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Posted by Economics news headlines | Money Supply | FT.com | Report as abusive

Yes, they can go broke. The Federal Reserve cannot technically go broke because it has the right to print or create money while all or most other banks (especially those in Europe) are not allowed to print new money without express permission. This is left over from World War 2 and must come to an end. The United States made a bad example by lending to the criminal banks in New York City – ‘Too Big to Fail’ was actually ‘Too Big to Jail’ – and jail it should be for those men and women who continue to sit at the helm of insolvent and criminal banks in New York. There will be no correction without their elimination and replacement.

Posted by cranston | Report as abusive

Central Banks operate via the Golden Rule. They make the “gold” so therefore they make the rules. The cannot go broke, not the least of which is because the money they print has no tangible backing like it did when money was based on Gold. Economists call this “fiat money.” In other words today’s money is based on smoke and mirrors and as such can be manipulated at the whim of the Central Banks. The power to manipulate the money supply creates boom-bust cycles that are used to determine the fate of societies all over the world. Dumping more money into the existing supply devalues it and raises prices and borrowing rates. This is called, inflation, and inflation is nothing more than a form of taxation that the vast majority are blind to. A wealthy man once said the definition of a recession is, “when all the money goes back to its rightful owners.” With our fiat monetary system this “redistribution” is exactly what is happening, and will continue to happen. And after everyone is slowly but surely brought to their economic knees, the banks will claim “insolvency” which will justify a one-World currency. At that point you can kiss Liberty, Democracy, and Free-Market economies, goodbye, and say hello, to a Socialist World Empire.

Posted by GLK | Report as abusive

Yes, they can go broke.
As long as the Bankers are getting rich fleecing the World via charging perpetual interest on re-packaged loans they know full well will NEVER get paid back, the IMF will never allow that to happen until the day comes when they use “manufactured insolvency” as an excuse for a one world monetary system. In the meantime the little people’s spending power will continue to slowly erode as it has been doing for decades.

Posted by GLK | Report as abusive

Who or which will borrow money to the banks with an interest of 0,1 % per year? – when it will take 1000 years to get a full return, and the likelyhood of having the bank going broke in 1000 years is 1?
So no bank in the US or Europe is paying enough to compensate for the risk.

Who or which will keep the money out of the banks and under the bed when no central bank governor can maintain purchasing power of the currency?

So why should you USD or Euro?

So if you have money — buy whatever you can in real assets to save the day. As there are more money out there than the value of all the goods – this means inflation. We will have superinflation.
It is the only way out.
Because we don,t have any brave politicians and they don,t have any track-records?

We have to realize no one wants to pay and the Federal Reserve was broke already in 2008 and the European Central bank got broke this year.

Posted by hilding | Report as abusive