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Can the Eurozone National Central Banks create fiat Euros by themselves?

by Migeru Wed Dec 1st, 2010 at 07:21:58 AM EST

In Can Central Banks Go Broke? (CEPR Policy Insight No.24), Willem Buiter asks:

Does it matter if a central bank suffers a large capital loss? Can the central bank become insolvent? How and by whom should the central bank be recapitalised, should its capital be deemed insufficient?
But he also does something else: this is one of the most accessible places where one can find a discussion of the structure of the ECB and its relationship with the National Central Banks.

While it answers many questions one might have, it also leaves a few important issues unresolved or undiscussed. In particular, the paper invites the question of whether National Central Banks can create fiat money independently of the ECB.

Follow me below the fold for some extended quotes from Buiter's paper.


... For the euro area, [the stylised conventional balance sheet of the central bank] is the consolidated balance sheet of the ECB and the 15 NCBs of the euro area.
Okay, so what does a central bank balance sheet look like?
On the right-hand-side of the T-account are the liabilities and shareholder equity of the central bank. First, there are its monetary liabilities, M, sometimes called base money or high-powered money. It is the sum of currency in circulation and balances or reserves held

For simplicity, I shall treat the whole of the base money stock as non-interest-bearing. This is certainly the case for currency, but interest is sometimes paid on commercial bank reserves held with the central bank. The central bank also has non-monetary liabilities, O. This can be debt to the government, to the domestic private sector, to international organisations like the IMF, or to the rest of the world. It can be denominated in domestic currency or in foreign currency.

As assets the central bank has Treasury debt, D, that is, sovereign bonds (Treasury bills and bonds), sovereign-guaranteed debt and, in federal systems, sometimes the debt of lower-tier governments (state, provincial, municipal); private debt, L, that is, outright or collateralised loans to the private sector and other private securities and instruments of all kinds (domestic or foreign); and official foreign exchange reserves, R. The currency denomination of assets other than foreign exchange reserves can be either domestic or foreign.

For simplicity, think of all asset and liabilities - M, O, D, L and R - as marked-to-market. Where there is no market, fair value valuation is applied. The financial net worth or (conventional) equity of the central bank, W, is residually determined as the excess of the value of the assets over the value of the other liabilities

So, what does the ECB balance sheet look like? (Or, rather, what did it look like in mid-2008?)
The balance sheet of the ECB for end-year 2006 and 2007 is given in Table 4, that for the consolidated Eurosystem (the ECB and the 15 NBCs of the Eurosystem) as of 29 February 2008 in Table 5. The consolidated balance sheet of the Eurosystem is about 10 times the size of the balance sheet of the ECB, but the equity of the Eurosystem is about 17 times that of the ECB. Gearing of the Eurosystem is therefore quite low by central bank standards, with total assets just over 19 times capital.

Between the end of 2006 and end-February 2008, the Eurosystem expanded its balance sheet by €237bn. On the asset side, most of this increase was accounted for by a €67bn increase in claims on the euro area banking sector and a €150bn increase in other assets. Both items no doubt reflect the actions taken by the Eurosystem to relieve financial stress in the interbank markets and elsewhere in the euro area banking sector.

Now for the ECB equity: who owns it?
The ECB is owned by the 27 national central banks (NCBs) that make up the EU's European System of Central Banks (ESCB). Note that it is the NCBs of all EU members (currently 27) that constitute the shareholders of the ECB, not just those who are part of the Eurosystem and have adopted the euro (currently 15). The NCBs themselves have a variety of formal ownership structures.
In detail:
The capital of the ECB is ECU 5 000 million. The capital may be increased by such amounts as may be decided by the Governing Council acting by the qualified majority provided for in Article 10.3, within the limits and under the conditions set by the Council under the procedure laid down in Article 42. The national central banks shall be the sole subscribers to and holders of the capital of the ECB. The subscription of capital shall be according to the key established in accordance with Article 29. Article 29 states that 'Each national central bank shall be assigned a weighting in this key which shall be equal to the sum of: - 50% of the share of its respective Member State in the population of the Community in the penultimate year preceding the establishment of the ESCB; - 50% of the share of its respective Member State in the gross domestic product at market prices of the Community as recorded in the last five years preceding the penultimate year before the establishment of the ESCB. ... The weightings assigned to the national central banks shall be adjusted every five years after the establishment of the ESCB by analogy with the provisions laid down in Article 29.1.'
Now, on to the interesting question of the interaction between the European Central Bank and fiscal policy:
However, the fact that the central bank is, from a financial point of view, an integral part of the state, does not depend on the formal legal niceties of stock ownership. Even if the central bank has formal or de facto operational independence, it is an integral part of a sovereign state. Their balance sheets and profit and loss accounts should be included in the consolidated financial accounts of the nation state to which they belong. The special issues this creates for a supranational central bank like the ECB will be discussed below. The common practice of analyzing public sector debt and deficits using the general government measure of the public sector, which includes Federal/central, state/provincial and local/municipal governments but excludes the central bank, is an unfortunate one.
(my emphasis)

Now for the lender of last resort function

Unique complications arise in the euro area, where each national fiscal authority stands financially behind its own NCB, but no fiscal authority stands directly behind the ECB. The lender of last resort function in the EMU is assigned to the NCB members of the ESCB (see Padoa-Schioppa (1999), Goodhart (1999) and Lastra (2000)). This will work fine when a troubled or failing bank or other financial institution deemed to be of systemic importance has a clear "nationality", legally and politically, as most euro area-domiciled and registered banks and other financial institutions do today.
Note, however, that lender of last resort action involves the creation of "high-powered" or "base" money by the Central Bank. Does this mean the National Central Banks retain the independent ability to create "base" or "high-powered" base money independently of the ECB or the ESCB?

Buiter is mostly concerned with the issues of cross-border banking, the distinction between subsidiaries and branches of a foreign bank, and the possibility of a bank being "incorporated solely under European Law" - which is at the moment hypothetical but which might well happen. The problems this creates are as follows:

It would seem natural that the ECB itself rather than one of the euro area NCBs would provide lender of last resort facilities for EU-banks. But who stands behind the ECB as recapitaliser of last resort? Not the European Community, which has a tiny budget, (just over 1 percent of EU GDP), no discretionary taxation powers and no borrowing powers. Also, even if the European Community were to evolve into a serious supranational budgetary entity, with independent powers to tax and to borrow, it would not be the appropriate fiscal back-up for the ECB, unless all EU members were also members of the euro area. As of today, there are still 12 EU members that are not part of the euro area.

If it is to be the euro area national Treasuries that will provide fiscal back-up for the ECB, in what proportions will they share the fiscal burden of recapitalising the ECB, should the need arise?

There is one readily available key for distributing the fiscal burden of recapitalising the ECB if in the future its balance sheet is impaired as a result of lender of last resort operations or market maker of last resort actions vis-à-vis EU-banks. This would be for each euro area Member State national Treasury to pay a share of the bail-out costs equal to the share of its NCB in the total share capital of the ECB, divided by the sum of the shares of all euro area NCBs in the total share capital of the ECB. Other formulae can be thought of, but it would be wise to have something agreed before the first EU Bank incorporated under EU statute law pops up and goes belly-up.

But in his analysis of the hypothetical, Buiter keeps putting his finger on a key feature of the actual, that is, the National Treasury-Central Bank team is the one with the responsibility (and the legal capacity, one must assume) for resolving and recapitalizing failing banks. Again, and excuse me if I repeat myself, does this mean the National Treasury-Central Bank team has the ability to create "high-powered" or "base" money independently of the ECB or ESCB?
The central bank-Treasury team is naturally, indeed umbilically, linked in conventional nation states with a single national central bank and a single national Treasury. The euro area has a single central bank, the ECB, which works through an operationally decentralised system of national central banks, the Eurosystem, but works alongside (and at times at crosspurposes with) 15 national fiscal authorities. As long as the nationality of a bank is clear (legally through clear rules of domicile, registration and incorporation and politically through the importance of the bank in the national financial system or as an employer) the appropriate NCB and national Treasury can handle the necessary lender of last resort and recapitalisation responsibilities. Even today, the growing complexity of cross-border banking activities in the euro area may be creating ambiguities and doubt as to who are the lender of last resort and recapitaliser of last resort for specific banks with a range of border-crossing activities, branches and subsidiaries.
In this connection, when Spain created its bank restructuringbailout fund, the FROB, it was designed so that it would have to raise capital in the money markets. No "high-powered"/"base" fiat money was injected directly by the Bank of Spain. I suspect the same is true of other bailout funds created in other EU states in the last 3 years. Indeed, how does Buiter's claim that the national Treasury/Central Bank team is joined umbilically and can adequately cary out lender of last resort and recapitalization functions square with the following provision of the EU Treaties?
Article 123
(ex Article 101 TEC)
  1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as "national central banks") in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

  2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.

Display:
Wondering whether the title should have a (Wonkish) alert, even for this here community blog...

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Wed Dec 1st, 2010 at 07:25:10 AM EST
I think we need to get a much better level of understanding of the central bank branch of the government, so I think it is properly wonkish.

Maybe you should email Buiter the questions we collectively fail to answer.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Dec 1st, 2010 at 03:52:29 PM EST
[ Parent ]
Buiter has, alas, for the last year or more, been a full time consultant to Citi Bank, and, for that reason, was obliged to cease publishing his Maverecon blog. Given Citi's situation I would expect him to have to be very circumspect regarding any public utterances.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Dec 2nd, 2010 at 04:55:47 PM EST
[ Parent ]
European Tribune - Can the Eurozone National Central Banks create fiat Euros by themselves?
As long as the nationality of a bank is clear (legally through clear rules of domicile, registration and incorporation and politically through the importance of the bank in the national financial system or as an employer) the appropriate NCB and national Treasury can handle the necessary lender of last resort and recapitalisation responsibilities.
So, what happened in Ireland? Why was the Irish Central Bank unable to act as a lender of last resort for its banks, fording the Treasury to guarantee all their liabilities and create NAMA as a "bad bank" solution? And why couldn't the Irish Central Bank support the Irish treasury in the recapitalization of the Irish banks?

Note, however, that the current Irish Central Bank Governor, Patrick Honahan, was appointed just over a year ago and earlier this year issued a scathing report on the domestic mismanagement which led to the Irish financial crisis, including

Dr Honohan found that the Financial Regulator was "excessively deferential and accommodating" to the banks, while the Central Bank, led by his predecessor John Hurley, had not been alert to warnings signs of an imminent crash.

There was insufficient awareness or willingness to accept "how close the system was to the edge" and that it was the responsibility of the Central Bank and the regulator to pull it back from the edge, he said.

"Rocking the boat and swimming against the tide of public opinion would have required a particularly strong sense of the independent role of a central bank in being prepared to `spoil the party' and withstand possible strong adverse public reaction," Dr Honohan said.

Pat Neary, the former chief executive of the regulator, said he had no comment. Mr Neary's predecessor, Liam O'Reilly, and Mr Hurley could not be reached for comment.

So he cannot be held personally responsible for the mess up to and including the creation of NAMA, but what was his role in the lead-up to the recent Irish bailout?

Honahan explained the purpose of the recent EU loan to Ireland as ThatBritGuy:

to show that Ireland has sufficient firepower to deal with any concerns of the market. That's the purpose of it," he told RTE.
I think at the rook of all this is the inability of the Central Bank to fund the Treasury. The Eurozone construction is definitely lopsided, where the Tresury is supposed to act as a fiscal backstop for recapitalizing the Central Bank should the need arise, but the Central Bank cannot fund the treasury except in Germany:

Deutsche Welle: Germany's Bundesbank Posts Huge Profits for 2008 (10.03.2009)

The entire sum earned is being transferred to the federal government -- which is something of a novelty. In previous years, portions of the Bundesbank's earnings have had to be used to pay off debt from the former East Germany, but now that the debt is gone, the bank's profits will flow into state coffers.


Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Wed Dec 1st, 2010 at 08:29:11 AM EST
Migeru:
So, what happened in Ireland? Why was the Irish Central Bank unable to act as a lender of last resort for its banks, fording the Treasury to guarantee all their liabilities and create NAMA as a "bad bank" solution? And why couldn't the Irish Central Bank support the Irish treasury in the recapitalization of the Irish banks?
In other words, maybe this is not true necessarily...

Can the Eurozone National Central Banks create fiat Euros by themselves?

lender of last resort action involves the creation of "high-powered" or "base" money by the Central Bank
See also this thread.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Wed Dec 1st, 2010 at 08:59:26 AM EST
[ Parent ]
By the way, this
the Central Bank cannot fund the treasury except in Germany
was snark. The NCBs still transfer profits to the Treasuries. What they cannot do is buy their debt at issue or give any other credit.

However, Central Banks are rather small and so are their profits. The equity of the Bank of Spain is €2bn and its profit is of the same order - about 0.2% of Spain's GDP.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010

by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 02:58:39 AM EST
[ Parent ]
who comments rarely now he works for Citi... Brought this out the other day:

Sovereign Debt Crisis Update (pdf).

by afew (afew(a in a circle)eurotrib_dot_com) on Wed Dec 1st, 2010 at 03:32:13 PM EST
Thanks, that is a good paper.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 02:53:40 AM EST
[ Parent ]
I think its in the Article 123 provision, allowing the NCBs to act as lender of last resort to commercial banking, but not to their Treasuries.

In the US, when we want to pretend that the Fed can not act as public lender of last resort, we put in place regulations restricting the Fed to purchasing of bonds on the open market, and force the Treasury to pretend that it is selling the bonds to private holders, who turn around and sell to the Fed in pursuit of their Federal Open Market Committee actions in defense of their target cash rate.

But that pretense is a policy decision, not a structural requirement, and if it were to become inconvenient at a time when it was politically feasible, could readily be reversed ~ we have at some points since WWII have had direct purchases of Treasury security by the Fed, which is the above without the pretense (note that the pretense is useful for transactions income for the FIRE sector).

If an NCB was to purchase its own Treasury's securities to maintain a target long term interest rate, from private holders, that would make a market for the Treasury to sell those securities.

And in a self-fulfilling prophecy, if they act to make that market, the Treasury securities up to the amount that they elect to purchase will be worth precisely the interest rate terms at which they purchase it.

The moral hazard for a district central bank buying public non-sovereign debt from a provincial government is whether it can afford the debt service. In a conventional central bank, surplus income is returned to Treasury, so when it holds sovereign debt, there is no question of being able to afford the debt service.

So the question is: if an ECB member NCB has a surplus of revenue over costs, does it still return the surplus to its national Eurozone government? If so, it seems like it ought to be able to make a market in the debt of its own national government.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Dec 1st, 2010 at 03:41:32 PM EST
So the question is: if an ECB member NCB has a surplus of revenue over costs, does it still return the surplus to its national Eurozone government?

Yes. ECB profits flow to the NCBs, but not the other way around.

But the NCBs take marching orders from Frankfurt.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Dec 1st, 2010 at 04:16:38 PM EST
[ Parent ]
In what sense do they take marching orders from Frankfurt ... in the sense that they toe the party line, or in the sense that a Fed Reserve Bank implements any action ordered by the Federal Open Market Committee because the FOMC says so?

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Wed Dec 1st, 2010 at 05:33:25 PM EST
[ Parent ]
I don't know what the formal chain of command is. But a couple of years ago, before the crisis, Italy suggested using its own central bank to run its own monetary policy. The ECB threatened to stop clearing payments with the Italian central bank if they did so, and the Italians backed down.

But I don't know how much of that was the typical theatre between Frankfurt and Silvio Corruptioni and how much of it was serious policymaking.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Dec 1st, 2010 at 08:44:20 PM EST
[ Parent ]
If the ECB has the independent authority to do that, they have the authority, as opposed to just leading the party line, since its the payments clearing function that is central to a central banks ability to function as the lender of last resort.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Wed Dec 1st, 2010 at 10:44:23 PM EST
[ Parent ]
Well, I don't know whether they have that authority. The ECB likes to give the impression that it has authority that it does not formally have according to the treaties.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Dec 1st, 2010 at 11:10:55 PM EST
[ Parent ]
Sorry my ignorance.. what is "payment clearance " in this context... the italian introduce the extra number in the right (or left) column of the balance-sheet and.. voala...

I guess I am missing something...what?

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Dec 3rd, 2010 at 06:38:57 AM EST
[ Parent ]
Central banks act as clearinghouses for payments between regular banks. The fact that each bank has an account and reserves at the central banks allows them to trust each other and credit each other payments even if there's a delay in money actually changing hands.

In the case of cross-border banking you need central banks to clear payments with each other. The ECB might act as a clearinghouse for payments among national central banks. If that is the case and the ECB refused to clear payments with the Italian Central bank, the Italian monetary system might become cut off from the rest of the EU.

At least as I understand the situation.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010

by Migeru (migeru at eurotrib dot com) on Fri Dec 3rd, 2010 at 07:07:12 AM EST
[ Parent ]
Can't the italian central bank act as a clearing house?. I thought any national central bank can have the account number of any bank. So the spanish central bank has the account of the spanish and any foreign bank.. so if any bank wants to put money in an Spanish bank it can go to the spanish central bank...if a spanish bank gives money to a german bank, the spanish central bank can move the money directly to the account.. if te ECB blocks it, it is the foreign bank problem..and it can always request the spanish cnetral bank to increase its acount in the spanish central bank vor create one.. isn't it?

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Dec 3rd, 2010 at 07:36:12 AM EST
[ Parent ]
But if the Italian Central Bank is shunned as a counterparty by the rest of the Eurozone central banks, foreign banks not regulated by the bank of italy may withhold any reserves they hold with the Italian Central Bank. Moreover, they may refuse to extend credit to Italian banks on the argument that their Lender of Last Resort is not creditworthy.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Fri Dec 3rd, 2010 at 08:57:52 AM EST
[ Parent ]
Central Banks are not in fact necessary for this credit/payment clearing function as a 'central counterparty' analagous to an exchange clearing house.

In Hong Kong, the Hong Kong Monetary Authority oversees the centralised clearing system in which all the Hong Kong clearing banks (also note issuers) participate. Because Hong Kong's is a 'real-time' settlement system, there is no need for a central counterparty as a 'risk intermediary' because there is no risk.

I explicitly referred to this some ten years ago when the implications sank in of 'Peer to Peer' connectivity - and a decentralised, dis-intermediated 'Market 3.0' -  in the aftermath of a market-centric Dot Com I set up.

Market 3.0: the final version

In a spot transaction the two functions take place contemporaneously and the exchange of value is conditional: if I don't have the shares, I can't offer them for sale, and if I don't have the money, I can't bid for the shares.

The consequence of this is that for true real-time settlement of a spot transaction, there is no requirement for a risk intermediary such as a central counterparty because there is no risk. Where there is an element of time between the conclusion of the contract and its settlement, then this introduces the requirement for risk management, and the interpolation of a risk intermediary such as a central counterparty or insurer.



"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Fri Dec 3rd, 2010 at 09:02:10 AM EST
[ Parent ]
ChrisCook:
Because Hong Kong's is a 'real-time' settlement system, there is no need for a central counterparty as a 'risk intermediary' because there is no risk.
You still have to deliver banknotes to settle balances occasionally?

There is no way to completely eliminate settlement risk.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010

by Migeru (migeru at eurotrib dot com) on Fri Dec 3rd, 2010 at 09:08:12 AM EST
[ Parent ]
Migeru:
You still have to deliver banknotes to settle balances occasionally?

There is no way to completely eliminate settlement risk.

The clearing banks issue Hong Kong Bank Notes, except for the lowest denomination HK $10 notes which are issued by the HKMA.

These notes get credited to bank accounts when paid in to a branch, thereby generating a (real time) credit in the system. While they are circulating, the issuers benefit from the Seigniorage.

The only settlement risk here is of counterfeit currency notes.

This is slightly different from the situation in Scotland, where Scottish Bank Notes must be matched - during the working week - by funds deposited with the Bank of England. Over the week-end the Scottish banks benefit from the Seigniorage....an interesting hybrid.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 3rd, 2010 at 09:38:45 AM EST
[ Parent ]
It seems to me that the major function of central banks in foreign transaction clearing is to allow only the net difference to ever have to be transferred. But the sticking point will always be the case of persistent current account deficits with specific countries. So European national central bank to national central bank clearing could work so long as the current account balances remained close to zero or within a range deemed acceptable by the bank carrying the deficit. Such an arrangement would tend to make such deficits either self limiting or at the discretion of the surplus country, as is the case between the USA and China. Such an arrangement might be a little too obvious to suit the desires of Germany, however.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Dec 3rd, 2010 at 10:58:23 AM EST
[ Parent ]
In line with the details up there, the basics are that one bank receives a check drawn on another bank, the payment is cleared between the two banks by a transfer from one bank's account at the Central Bank to the other bank's account. Those accounts are assets of the commercial banks and liabilities of the Central Bank. Since its a transfer from one bank's reserve account to another, there is no change to the total liabilities of the Central Bank.

The fact that payments clear at the central bank means that if the central bank can always clear Treasury checks by accepting the IOU of the Treasury as an asset and increasing Central Bank liabilities by adding an equivalent amount to the Treasury account.

If the Central Bank for reasons of political theater is not allowed to do that, but it has an interest rate target to maintain, the Treasury auctions those IOU's, with payment ending up in its account at the Central Bank, and then that the Central Bank more or less ends up buying up those bonds to stabilize interbank interest rates.

The reason that the action of a conventional Central Bank action ends up (either directly or after the fact) eliminating the debt service burden on the Treasury is that the Central Bank is either owned by the government or chartered by the government as a not-for-profit, with any surpluses going back to the Treasury. So once Central Bank operating expenses are covered out of interest income on Treasury bonds they hold, all the excess goes straight back to Treasury.

Its the combination of the clearinghouse function and surplus on income over operating costs returning to the Treasury that ensures that Treasury checks never bounce. If the ECB can interfere with an NCB clearing payments, it can interfere with the NCB operating as a clearinghouse for payments across national borders, making reserve assets of commercial banks held in that NCB's accounts a second-class citizen, only good for clearing payments within the country.

That's why the question of whether the ECB is by treaty required, allowed, or not allowed to interfere with cross-border clearances between NCB's is of interest. And IANL, so even if I had the text, I could only guess how it would be interpreted by a court.

And whether an NCB in the Eurozone can get away with freelancing in this way ~ and I suspect that the Bundesbank had good enough lawyers to make sure that one way or another, the treaty terms do not allow that kind of freelancing ~ given the unsustainability of multiple cash rate policies in a single currency zone ~ that's what led to the formation of the Federal Open Market Committee in the US ~ there's also a quite reasonable argument that an NCB should not be allowed to engage in this kind of action.

I still prefer a system of determining the shortfall from full output, allocated on a per capita basis, and the ECB buying individual member state bonds on the open market equivalent to that amount ~ which would be a confederalization of fiscal policy.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Dec 3rd, 2010 at 01:21:11 PM EST
[ Parent ]
Excellent!!!

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Sat Dec 4th, 2010 at 07:33:35 AM EST
[ Parent ]
On the separation of funcions between the ECB and NCBs, there's this from the Bank of Spain.

Banco de España - Sobre el Banco - FuncionesBank of Spain - About the Bank - Functions
Funciones como miembro del SEBCFunctions as a member of the ESCB
Desde el 1 de enero de 1999 el Banco de España participa en el desarrollo de las siguientes funciones básicas atribuidas al SEBC: From 1 January 1999 the Bank of Spain takes part in the development of the following basic functions attributed to the ESCB:
* defining and executing the monetary policy of the Eurozone, with the principal objective of keeping price stability in the zone as a whole
* carrying out foreign exchange operations consistent with the provisions of article 111 of the Treaty on European Union, as well as holding and managing the official foreign reserves of the State
* promoting the good functioning of payment systems in the Eurozone
* issuing legal tender notes
Funciones como banco central nacionalFunctions as National Central Bank
Respetando las funciones que emanan de sus integración en el SEBC, la Ley de Autonomía otorga al Banco de España el desempeño de las siguientes funciones:Respecting the functions that flow from its integration in the ESCB, the Autonomy Law gives the Bank of Spain the responsibility for the following functions:
* holding and managing the reserves of foreign currency and precious metals not transferred to the ECB
* promoting the good working and stability of the financial system and, without prejudice of the BCE's functions, the national payment systems
* supervising the solvency and normative compliance of credit institutions, or other entities and financial markets it has been charged with supervising
* issuing coinage and carrying out, on account of the State, other functions relative to coinage
* elaborating and publishing statistics relating to its funcions and assisting the ECB in the compilation of statistical information
* providing treasury and financial agent services for public debt
* advising the government, as well as carrying out the necessary reports and studies


Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 05:25:39 AM EST
[ Parent ]
i swear watching you, mig and gang peeling back these onion layers is getting as exciting as watching a sherlock holmes mystery getting unravelled...

it's the story, and i sense a denouement approaching.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Wed Dec 1st, 2010 at 07:34:39 PM EST
[ Parent ]
if an ECB member NCB has a surplus of revenue over costs, does it still return the surplus to its national Eurozone government?
Yes, see my top-level comment
Deutsche Welle: Germany's Bundesbank Posts Huge Profits for 2008 (10.03.2009)
The entire sum earned is being transferred to the federal government -- which is something of a novelty. In previous years, portions of the Bundesbank's earnings have had to be used to pay off debt from the former East Germany, but now that the debt is gone, the bank's profits will flow into state coffers.
This is because the ECB's equity is owned by the 27 Central Banks in the ESCB and the equity of a National Central Bank is owned by its treasury. However, some decisions have been transferred by treaty to the ECB Governing Council or to the ESCB, and so are made collegially by the NCB Chairmen.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 02:51:46 AM EST
[ Parent ]
European Tribune - Can the Eurozone National Central Banks create fiat Euros by themselves?
I suspect the same is true of other bailout funds created in other EU states in the last 3 years.

Huh. Germany did it through the treasury.

Financing

To provide recapitalisation measures and to assume risk positions, the Federal Ministry of Finance can take out credit totalling up to 70 billion Euros. With the consent of the budget committee of the German Parliament, this credit amount can be extended an additional 10 billion Euros.

In case the Federal Republic of Germany takes out loans for the Fund, its net borrowing and debt level will increase. However, as the Fund can acquire participations in financial sector enterprises and receives fees as consideration for granted guarantees, the negative effects on the public budget are minimized. In addition, the Fund generates administrative costs. These costs are borne by the Federal Republic of Germany.


The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman
by dvx (dvx.clt št gmail dotcom) on Wed Dec 1st, 2010 at 04:40:13 PM EST
Which cannot borrow from the Bundesbank.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 02:47:16 AM EST
[ Parent ]
So, if the national tresuries are bearing the costs (including administrative!) of bank restructuring funds, is the European System of Central Banks jointly and severally in dereliction of duty?

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 05:41:14 AM EST
[ Parent ]
Hmmm, quite possibly severally, though I'm not sure about jointly.

This is quite possibly an issue that was inconceivable to the people who designed the system and framed the treaties, and if that's the case there is little guidance to be found either in the text of the treaties themselves or the records of the deliberations.

And given that the Eurosystem is, in institutional time, brand new, there is no precedent that can be sited.

So probably what it comes down to is: if an NCB decides it can create euros - and actually does so - then that will establish a precedent.

And if no NCB decides it can do so, that will set a precedent as well.

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman

by dvx (dvx.clt št gmail dotcom) on Thu Dec 2nd, 2010 at 04:06:25 PM EST
[ Parent ]
Crises are precedent-setting and the resolution tends to become the new normal.

Unfortunately, we seem to have idiots in charge of resolving the current crisis.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010

by Migeru (migeru at eurotrib dot com) on Fri Dec 3rd, 2010 at 07:08:58 AM EST
[ Parent ]
which I have considered myself. What would happen if say the Bank of Spain started creating loads of euros, as nothing more is needed than pushing buttons on a computer? Would the ECB say, -hey you guys you can't do that! to which the Bank of Spain answers, - well mates, we just did!

That would be a transfer of value from everyone holding euros to the Bank of Spain and it would cause some inflation, so I suppose we'd see Axel Weber marching south at the head of the second Condor Legion... :p

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Thu Dec 2nd, 2010 at 09:53:16 AM EST
See JakeS:
But a couple of years ago, before the crisis, Italy suggested using its own central bank to run its own monetary policy. The ECB threatened to stop clearing payments with the Italian central bank if they did so, and the Italians backed down.
Also:
A swedish kind of death:
European Tribune - Beggars can't be choosers
However the ECB could turn off the liquidity taps to the Irish Banks at any time thus effectively bankrupting them whatever the Irish Government might do.

Can it? How would it work?

If yes, could not the Irish government issue scrip in such a situation?

Migeru:
In that case the Irish banks would be insolvent and would have to be intervened by their regulator or national deposit insurance scheme. The assumption would be that the Irish government doesn't have enought cash even for a "Good Bank" resolution of its banks.
JakeS:
But that is ridiculous. Surely they have enough liquid assets to cover all domestic depositors?
Migeru:
After all we've seen in the last 3 years, I wouldn't bet my life savings on that surely...
Buiter in his paper on Central Bank insolvency does discuss the fact that the Central Bank can always make itself solvent assuming the liabilities of the economy are denominated in its own currency and not index-linked by seigniorage but sometimes at the cost of unacceptable inflation rates. So, effectively it is possible for a central bank/treasury combination to be jointly insolvent. Is that the case in Ireland? In fact, in the document linked to by afew: upthread
Buiter, who comments rarely now he works for Citi... Brought this out the other day:

Sovereign Debt Crisis Update (pdf).

Buiter claims
Accessing external sources of funds will not mark the end of Ireland's troubles. The reason is that, in our view, the consolidated Irish sovereign and Irish domestic financial system is de facto insolvent. The Irish sovereign cannot from its own resources `bail out' the banks and make its own creditors whole. In addition, a fully-fledged bailout (permanent fiscal transfer) from EA partners or the ECB is most unlikely. Therefore, either the unsecured non-guaranteed creditors of the banks, and/or the creditors of the sovereign may eventually have to accept a restructuring with an NPV haircut, even if it is not a condition for accessing the EFSF or the EFSM at present.


Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Thu Dec 2nd, 2010 at 10:24:31 AM EST
[ Parent ]
Yeah, I get that. What I don't get is what essentially could stop the Spanish and Irish central banks from saying "oh, we've found this account, and lo and behold, it contains 100 billion euros", and then just pay that money to creditors or whomever.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Dec 2nd, 2010 at 10:28:58 AM EST
[ Parent ]
I think we still do not know if they can print the euros legally (well, introduce them into the computer), if they can but there are marching order that the german army would invade the country, if it is illegal but you can try to game the system (and do it easily) or if it is illegal and you just can not rig the system.

I think this is the key point... and frankly I still do not know.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Dec 3rd, 2010 at 06:37:10 AM EST
[ Parent ]
... since they cannot buy directly from the Treasury, is buying Treasuries on the private market, putting them on their books as an asset, so writing up the liabilities of the extra reserve account entries credited to the sellers of the Treasuries.

But on what basis? Implementing common ECB monetary policy?

And if the ECB says, "those are not sound assets you have on your books, we are not accept payments from you until you clean up your books and have sound assets backing your liabilities" ... if the ECB can in fact make it stick, that's the end of that strategy.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat Dec 4th, 2010 at 08:44:26 PM EST
[ Parent ]


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