06 October 2013

Quick Glance at Central Banks’ Balance Sheets Reveals That…

Institutional bankers in the so-called Developed World have become skillful in managing the current economic and financial situation which might be described as “stable disequilibrium”. Despite that the issue of massive debt overhang has not just disappeared (what a surprise!) but is now as bad as ever or maybe worse*, the World of Finance as we know it is still there, and even looks like being recovering and turning back to profitability. Indeed, even the balance sheets of the heavily undercapitalized European banks** appear to become stronger. What’s the secret? Let’s take a quick look to the balance sheets of the three major central banks.

The balance sheet data below is as available at the end of September / beginning of October 2013:
The numbers are not exactly comparable across all central banks due to differing organizational structures, (accounting) practices, political choices etc. Yet they are still enough to make one raising eyebrows if nothing else.


The Fed: Factors Affecting Reserve Balances

Total assets: USD 3.8 trillion, out of which:
  • U.S. Treasury securities: USD 2.1 trillion (recorded in face value; ca. 13% of the total U.S. 16.7 trillion public debt outstanding, and nearly one fifth of all marketable securities)
  • Mortgage-backed securities: USD 1.3 trillion
  • All other assets: USD  0.4 trillion (=3.8-2.1-1.3)

Liabilities:
  • Currency in circulation: USD 1.2 trillion
  • Deposits held by depository institutions in the Fed: USD 2.3 trillion
  • All other liabilities: USD 0.3 trillion

Capital: USD 55 billion (billion, not trillion!), that is less than 1.5% of the total balance sheet. Wow! The Fed is leveraged by 68 times.

Now we think that the Fed is stuck to purchase additional longer term Treasury securities at a pace of $45 billion plus $40 billion of agency mortgage-backed securities per month; we have observed that every hint about tapering has resulted in the negative reaction on the financial markets. Imagine what would happen if the Fed tried to sell its assets…

One doesn’t need to be a genius to suspect a problem if banks wanted or needed their money currently deposited in the Fed…


ECB: Consolidated financial statement of the Eurosystem

Total assets: EUR 2.3 trillion, out of which:
  • Lending to euro area credit institutions related to monetary policy operations (MPOs): EUR 0.8 trillion
  • Securities of euro area residents: EUR 0.6 trillion
  • Gold and gold receivables: EUR 0.3 trillion
  • Claims on non-euro area residents denominated in foreign currency: 0.25 trillion
  • All other assets: EUR 0.35 trillion (=2.3-0.8-0.6-0.3-0.25)

Liabilities:
  • Currency in circulation: EUR 0.9 trillion
  • Liabilities to euro area credit institutions related to monetary policy operations (MPOs): EUR 0.5 trillion
  • Revaluation accounts: EUR 0.3 trillion
  • Liabilities to other euro area residents + Liabilities to non-euro area residents: EUR 0.25 trillion
  • All other liabilities: EUR 0.35 trillion

Capital: EUR 90 billion, that is somewhat below 4% of the total balance sheet.

This balance sheet looks more diversified and less leveraged than the one of the Fed. Furthermore, differently from the others, the ECB has actually managed to reduce its balance sheet by nearly EUR 0.8 trillion when compared to the peak in mid-2012. (On asset side, the reduction of eurosystem’s balance sheet comes from the item “Liabilities to euro area credit institutions related to MPOs” and on liability side from the item “Liabilities to euro area credit institutions related to MPOs”. In other words, banks have partly repaid the money that they borrowed in the two rounds of the longer-term refinancing operations known as LTROs.)

This may seem great but … apparently, the better-looking eurosystem’s balance sheet has come on the expense of weaker commercial banks’ balance sheets and struggling economies. In other words, new rounds of LTROs are likely to make it “exploding” again. One trillion would not stand out as particularly bad in terms of the ECB’s leverage – at least when compared to the other central banks. Then the pressing question concerning the ECB’s solvency would be about the asset quality, i.e. how creditworthy are the euro area banks and governments that borrow from the ECB or the securities of which the ECB owns. One might assume a matter of adverse selection.


Bank of England: Central bank's balance sheet

Total assets: GBP 402 billion, out of which:
  • Other loans and advances: ca. GBP 385 billion; these “Other loans and advances” consist more or less 100% of the loan to the Bank of England Asset Purchase Facility Fund Ltd which in turn has allocated more or less everything into the Gilts, i.e. into the U.K. equivalent of the U.S. Treasury securities  (See: Bank of England Asset Purchase Facility Fund Limited Annual Report 2012/13)
  • All other assets: about GBP 17 billion (=402-385)

Liabilities:
  • Central Bank sterling notes in circulation: GBP 60 billion
  • Deposits from banks and other financial institutions: almost GBP 300 billion
  • All other liabilities: ca. GBP 40 billion

Capital: It’s this little that it’s not even shown in the weekly consolidated financial statement.

So via the wholly owned subsidiary called Bank of England Asset Purchase Facility Fund Ltd, Bank of England has financed nearly 30% of the UK’s government debt (which based on the data as of at the end of Q1 2013 amounted to nearly GBP 1.4 trillion). According to the latest Bank of England’s Annual Report, “HM Treasury continued to indemnify the activities of the Bank of England Asset Purchase Facility Fund Ltd during the year.” In other words: effectively the HM Treasury is guaranteeing its own liabilities to the Bank of England?!

In any case, we have the same question that we asked about the Fed: What if the banks actually needed the money that they have deposited in the Bank of England? (Clearly, their deposits exceed the minimum regulatory reserve requirement which, at least based on the IMF’s 2011 working paper on Central Bank Balances and Reserve Requirements, is zero.)

There is always one simple answer: money printing, this time literally – and that’s a very slippery road.


To finish the sentence in the headline: Quick glance at central banks’ balance sheets reveals that behind the current state of stable disequilibrium is a massive market manipulation by the central banks, called unconventional monetary policy. The values of major currencies are closer to falling into zero than one might think. On the other hand, nothing needs to happen until central bankers manage to convince third parties such as general public and creditors from the rest of the world that the developed economies are gradually recovering (the impression of which looks like a statistical trick rather than anything else) and that public debts can at some point be repaid without simply inflating them out  (even if the market value of the debt is being held up artificially).


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* Add up all non-financial debts (i.e. the debts of households, non-financial enterprises and public sector) and you’d see. What has really happened is that a part of the private sector debt has been converted to the public debt. That’s it; the debt is still there.
** “Heavily undercapitalized European banks” – this issue would definitely deserve a post on its own. For now one might think about the fact that the total equity of all banks in the Eurozone is less than EUR 2 trillion (Source: ECB, Consolidated Banking Data as of 31 Dec 2012), while the total debt of the non-financial sector exceeds the estimated sustainable level by EUR 5 trillion. (“Putting everything into one pot”, i.e. introduction of the full-fledged European Federation would reduce the excess debt to EUR 2-3 trillion based on the assumption of excess countries financing the debts of the deficit countries). The calculation of the excess debt is based on the threshold sustainable debt levels of 160% of GDP for the non-financial private sector plus 60% of GDP for the government. The thresholds are the same as applied by the European Commission in the “Alert Mechanism Report – 2013”.

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