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Chart of the Day: could QE bankrupt the Fed?

It's an important question when central banks' answer to the financial turmoil of the past few years has been to throw money at the problem.

 

by Chris Marshall on Aug 25, 2011 at 09:47

There is something fundamentally amiss with the banking system: if a commercial bank, say Lloyds, needs more money it gets it from the government. If a central bank needs more cash it starts the printing presses.

But can central banks – most notably the US Federal Reserve and European Central Bank – actually go bust if they keep this up? It seems an important question when their answer to the financial turmoil of the past few years has been to throw money at the problem, and when markets are hoping that Fed chairman Ben Bernanke will on Friday announce a third round of asset purchases, AKA quantitative easing, AKA QE3.

ING’s Teunis Brosens has done the sums and finds that if you compared central banks with commercial banks they wouldn’t pass muster. He concludes that any commercial bank with the Fed’s tiny capital cushion (ie its assets minus its liabilities, shown in the graph below) of $51.8 billion or 1.8% of its assets, ‘would immediately be declared insolvent and shut down’.

The ECB fares slightly better, with capital of €81 billion or 4.9% of assets (see second chart, below). But as Brosens notes, it would theoretically fail the Basel III global standard for commercial banks, were it to apply. This states that banks must hold a minimum of 7% Tier 1 capital (Lloyds again as an example has a tier 1 capital ratio of 10.1%)

Owing to their money issuing abilities, Brosens concludes that ‘technically speaking, in most circumstances the central bank cannot go broke’.

But he points out the fundamental flaw to the money-printing-their-way-out-of-trouble approach, the same concern that some economists say will stay Bernanke’s hand on Friday: inflation.

‘Losses may force the central bank to print more money than it would like, which – in the case of an inflation-targeting central bank, such as the Fed or the ECB – brings it into direct conflict with its prime policy objectives.’

Therefore, it’s their credibility as inflation fighters that is put at risk, not their ability to stay afloat.

27 comments so far. Why not have your say?

Evan Owen

Aug 25, 2011 at 12:35

What's wrong with a bit of inflation? Should they strike it off the policy list for a while?

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Tony Marshall

Aug 25, 2011 at 12:36

Ultimately, macro-economics is nothing more than a matter of timing: sooner or later, populations either have to pay in kind for what they want from others - whether out of natural resources or human resources - or they have to go to war and steal what they want. Money drops out of the equation.

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Robin McEvoy

Aug 25, 2011 at 12:45

Every £ or $ printed is another added to the total debt. It's a case of do we want to start paying off a huge debt now, or a humungous one later when there is no chance whatever of paying it off even in our great grandchildren's lifetime?

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Simon Baggott

Aug 25, 2011 at 13:37

Rember Zimbabwe?

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82 yo

Aug 25, 2011 at 13:43

Frightening - is it not really the capitalism that is at risk of failing - we had communism fail - what is there to replace capitalism ? we must grasp the nettle - we do not have the politicians capable of even understanding the problem never mind solving it - frightening !

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Terminator

Aug 25, 2011 at 13:46

Money printing in the UK has already been on the go for many years.The absurd 1997 - > property bubble started by the Blair administration and the banks has caused untold damage, we've yet to see the worse.

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William Bishop

Aug 25, 2011 at 15:29

As a generalisation, a central bank going bust seems an unlikely scenario, as the relevant government would presumably always be standing behind it, with a greater degree of certainty than for a commercial bank considered "too big to fail". Maybe the ECB could be more at risk, spending money like a drunken sailor on questionable bonds and having no single government backing it. Might be liable to have to fall back on the Germans, who not only would be reluctant to bail out in any case, but also do not approve of the bond buying. But maybe they would ante up if assured of a return to total financial prudence as originally exemplified by the Bundesbank??

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snoekie

Aug 25, 2011 at 15:38

Power corrupts, and in this case the power of the central banks to print money has corrupted them from their primary duty, to manage the finances of the State in a sensible, honest way.

Were they confronted by a commercial bank dealing in that way they would close them down in a flash. Time for a super ombudsman to confront and correct the erroneous ways of the central banks, and that must include the 'orders' from politicians.

If they want to lend to a commercial bank, they must have the funds, otherwise they must decline the loan. States must learn to handle their finances in the same way that businesses or households must deal with their finances, sensibly.

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Jack Porter

Aug 25, 2011 at 16:51

Whatever happened to our "National Debt"

Surely, at one time we aspired to repaying it? Gordon Brown made sure we would not be able accomplish that...

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J

Aug 25, 2011 at 16:56

On the other hand, if we did not have QE1 and QE2... I shudder to think.

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Anonymous 1 needed this 'off the record'

Aug 25, 2011 at 17:26

The Piper needs paying. QE1,QE2 and QE3 is like the alcoholic reaching for a drink to avert a hangover rather than going into rehab. How long untill liver failure occurs is the question?

Also who gets screwed is really what we should be asking. Ordinary folk on less than inflation pay rises and pensioners/people on fixed incomes. Meanwhile Goldman sachs et al walk off with increased profits/bonuses.

is it really that hard to understand?

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Truffle Hunter

Aug 25, 2011 at 17:27

QE will not bankrupt the FED as the US Dollar is the world's principal Reserve Currency, but they will seriously impoverish anyone holding the currency over time. The same applies to most fiat currencies. Gold and silver is real money and cannot be created by political dictat. Long term savings are best kept in these mediums whilst the current negative real interest regime persists, as conditions are unlikely to improve for years. When the bond markets demand higher interest rates above the rate of inflation, that will be the time to unwind the precious metal position. In the current conditions most assets will fall in terms of gold and silver.

As long as the US and other governments fail to understand the difference between illiquidity and insolvency the stagflationary nightmare will continue.

The wrong medicine was applied in 2008; banks should have been forced to take the write downs and the "stimulus" given back to the people in the form of tax cuts rather than tax payer loans to the banks.

I note today that Buffett has kindly offered to bail out the Bank of America with some $5bn of petty cash. I wonder what prompted that?! The Western financial system is as sick as Monty Python's dead parrot.

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Neil Murphy

Aug 25, 2011 at 17:53

Truffle Hunter, Buffet's payment was not an act of charity, he will be seeing a bargain lurking in there.

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John Pennell

Aug 25, 2011 at 18:04

The really encouraging thing about the liabilities is the 40% in banknotes. How many of these have been lost or destroyed, or are so well hidden that their owners will never find them to 'cash' them in.

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Terminator

Aug 25, 2011 at 19:38

For the UK in particular it still all goes back to the Blair tenure @1997 - > and their obsession along with the banks of creating money via property values. What happened is a national disgrace and all involved should be deeply ashamed. Anyone during that ridiculous period who saw their properties value rise for eg %100 in 6 months (yes that happened) and pocketed £100 -200 UPWARDS by selling it would have surely known that they were participating in a piece of economic history. A moral dilemma for sure but how many people turned round and said "but hold on, this cant be right". My guess is a big fat zero and if I'm honest I would have been the same.(I personally wasn't involved in this) What ensued was a bloodbath and the rest is history. The fault lies squarely with the government and their policies. They are elected to govern for ALL the population not just the half that constantly pursue vast amounts of money and will turn over any stone in order to get it. As Truffle Hunter states, the banks SHOULD have been forced to take the loss. It may make them think again before they 'invent' some money to lend someone who wants to make a killing in property on a 125% LTV basis. The problem we face today is that so many people were at it, it became a prime source of 'wealth' at the mind boggling expense of many ordinary people and created a two tier system between people who have tons of funny money and the rest who don't.

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Terminator

Aug 25, 2011 at 19:40

The £100 - 200 above should read £100 -200K.

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Truffle Hunter

Aug 25, 2011 at 19:48

I agree it's not exactly charity, but the stiff terms of Buffet's deal make one ask the question: how big is the hole that B of A finds itself in? They are not the only bank in a spot of bother.....

I await with interest the month of September when JP Morgan may find itself in more than a little difficulty. The New York DA is currently looking into the actions of this bank around the time of the 2008 Crisis. Several highly credible whistleblowers have given the DA what could be devasting evidence of potential criminality. The DA means business just like Elliot Spitzer in the days of the "savings & loans" crisis of the 1980's. He wants to make his name by jailing some of the bankers. The only fly in the ointment is the possibility that people in the SEC have "accidentally" shredded a lot of documentary evidence. The revolving door between bank and regulator shows just how corrupt the whole system really is. By some accounts JP Morgan might take a $10Bn hit if the DA can make the charges stick.

Damning evidence may start to come to light in the next month.

Forearmed is forewarned.

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Terminator

Aug 25, 2011 at 20:52

A quote on banks/bankers from David Brooks, New York Times: -

"Many thought we should let these rational wealth-seekers get on with it. We shouldn't."

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Evan Owen

Aug 25, 2011 at 21:17

Could someone please put them out of our misery?

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Terminator

Aug 25, 2011 at 23:03

It seems to me that both the US and the UK need draconian restrictions on Banks and their activities.

The ability to 'create money' at will is not one granted to ordinary citizens therefore those who do have it should be far more closely scrutinised/controlled.

Having seen personally the damage that can be done here (UK) which, believe it or not, over ten years later, is still yet to be fully realised and having noted the crisis in the US, it should be clear to right minded people that far far more control is needed by respective governments.

Problems arise, however via a major conflict of interests, as how many MPs/Congressmen are also active in the financial sector in one form or another (banker/broker/lawyer/risk assessor/insurer/shareholder/ceo/director) the list is endless.

To ask them to pass laws which will potentially damage their own

financial progress is extremely hazardous, probably naive at best.

Throw in other complications such as corruption and fraud,

favours owed to various, general lapses in morality + activities far more esoteric in nature and you've probably got a debate covering much more than is usual in this publication.

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IPD

Aug 26, 2011 at 04:54

Unless China de-couples its currency from the USD, this nightmare is going to continue. China won't do it, as politically their government in finished. And so it goes....

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Battler

Aug 26, 2011 at 10:09

I am sorry, but the comparison between a central bank's balance sheet and that of a commercial bank is a completely useless piece of analysis and a waste of the author's, this reviewer's and other readers' time. Fundamentally, the credit standing of a central bank depends on the strength of its shareholder, i.e. the government which "owns" it. As long as citizens are willing to accept the currency printed, the central bank is safe. It is only when the domestic currency is not acceptable that there is a problem with the central bank. This occurs at times of high inflation and that is why the control of inflation is a goal that is in every central bank's charter and that is why central banks have to have a degree of independence from political government.

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Truffle Hunter

Aug 26, 2011 at 11:03

Battler, trouble was that Schmoozer Greenspan just loved rubbing shoulders with the politicians. Greenspan, a former "gold bug" did a complete U turn and became a lapdog of the scumbag politicians.....fast forward to today where in Europe the "independant" ECB is now being taken over by the politicians.

The problem is the corrupted democratic political system. It is no longer fit for purpose.

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Simon Baggott

Aug 26, 2011 at 14:35

Yes indeed, the reason why a central bank can go bust is that its country goes bust. The Eurozone is a peculiarity, as it has several nation states, the first of which to go bust was Greece (I believe) which may not have paid off 10.5 billion euros of its national debt due on 19 and 20 August.

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Evan Owen

Aug 26, 2011 at 15:17

There is life after default.

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Pertan

Aug 27, 2011 at 12:38

Robin McEvoy wrote

"Every £ or $ printed is another added to the total debt. It's a case of do we want to start paying off a huge debt now, or a humungous one later when there is no chance whatever of paying it off even in our great grandchildren's lifetime?"

Actually the Fed is buying long-term Government debt (T bills and T bonds) with the QE money so total debt with outside lenders is not increasing. It is a move to keep long -term interest rates down in order to stimulate the economy, the short-term rates are already very low.. They seem to be more worried about negative GDP growth and deflation as in Japan, not so much about inflation at present. QE is a stimulance measure and at some point the extra money pumped in should be taken out again. Will that ever happen? that is the question

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Truffle Hunter

Aug 27, 2011 at 15:22

Will bond buyers purchase at todays coupon rate? NO!

They will at much higher rates of interest and at shorter durations on the debt curve. Any one lending to Western governments at these low rates is on to a hiding for nothing! The barman has called time on this bunch of credit-drunks.

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