Cashing in on intervention
by David Marsh
Mon 26 Jul 2010
Should central banks try to make a profit from their intervention operations?
The near-universal answer is no, but it certainly helps their own confidence if they do.
By buying or selling bonds or currencies, central banks are trying to help overall macroeconomic conditions rather than to make a quick buck for the taxpayer. However, the very fact that the central bankers themselves like to harp on about the profitability (or otherwise) of intervention indicates that they get quiet satisfaction from being able to call the market right.
We can see three significant examples of this during the present bout of capital markets uncertainty. The Bank of England has made nearly 10 billion pounds in paper profits by buying UK government bonds as part of post-crisis efforts to pump money into the British economy through quantitative easing (QE).
This began in March 2009 and involved purchasing nearly 200 billion pounds in gilts. Especially since the beginning of this year, UK governments bonds have been regarded as safe havens during the crisis of confidence affecting the euro -- pushing up their value and helping the Bank to a tidy paper profit.
Little of this was expected at the beginning of 2010. The view in financial markets at that time -- remember Bill Gross's combative comments from Pimco, a unit of Allianz SE, about the UK bond market being on a "bed of nitro-glycerine"? -- was that the UK's deteriorating fiscal position would drive gilt prices lower.
But the crisis in Economic and Monetary Union (EMU) changed all that. And this was the phenomenon that has affected the Swiss, too -- although in the opposite direction to the UK central bank.
The Swiss National Bank -- one of the most respected central banks in the world -- confirmed last week that it is nursing nominal losses in the first half of 2010 as a result of large-scale purchases of euro to head off a debilitating rise in the Swiss franc. Despite the intervention, the euro fell substantially in the first half of 2010 -- leaving a large-scale deficit for the normally ever-so-tidy Swiss.
The SNB is a publicly listed entity on the Zurich stock exchange. Public shareholders -- cantons and cantonal banks -- hold around 55% of the 25 million francs worth of the stock with most of the remainder owned by private individuals. Swiss municipalities are used to earning plentiful dividends from the SNB's operations -- but the payouts this year may be a lot less generous.
The SNB's operations are a bizarre highlight of long-running Swiss efforts during past decades to check the Swiss currency's well-nigh inexorable ascent. Massive currency intervention this year has resulted in the SNB becoming probably the world's large holder of euros, measured against the overall size of foreign exchange reserves. According to data published last week, more than 70% of the SNB's foreign exchange assets are in euros, versus 46% five years ago.
The SNB holds a total of 160 billion francs worth of the single currency, more than five times the amount last summer.
As one further episode of EMU tribulations, the European Central Bank, meanwhile, has purchased more than 55 billion euros worth of weaker euro members' government bonds (mostly from Greece) since May.
As a result, the ECB is sitting on a vulnerable bond portfolio, full extent of which will probably never be known. It is quite likely that the ECB will sell off its bond holdings to the new Luxembourg-based European Financial Stability Facility (EFSF) set up by euro members to protect the weaker members. EMU solidarity being what it is, it's more than conceivable that member governments will agree to foot the bill for any loses that ensure -- leaving the ECB's balance sheet intact.
That would be fair enough. After all, the UK Treasury agreed to indemnify the Bank of England for any losses that ensured from the quantitative easing program.
But do they matter?
Charlie Bean, the Bank's deputy governor for monetary policy, stated last October that the aim of QE was not to make profits. "The aim of Quantitative Easing and the Asset Purchase Facility is to help the Monetary Policy Committee achieve its macroeconomic objective, namely hitting the Government's inflation target without generating undue volatility in output."
He also pointed out that whether the Treasury ends up with a profit or a loss from the Asset Purchase Facility represents only a small part of the picture. "Gilt yields will be lower than they would otherwise have been during the period that they are held in the Asset Purchase Facility, so reducing the cost of financing a given budget deficit. This needs to be factored into any calculation of the implications for the public finances."
At the ECB, they seem to take a more narrow view of the profit-and-loss issue. Lorenzo Bini Smaghi, board member for international operations, in April last year went through six reasons why the ECB seems unlikely to adopt large-scale purchases of government bonds as decided by the Federal Reserve and Bank of England.
He voiced some very real doubts, including whether an increase in the monetary base results in easier monetary conditions; whether banks would actually pass on the additional liquidity in the context of de-leveraging; whether inflationary expectations would rise; and whether central banks would suffer large losses by buying a high prices and selling at low ones.
The ECB of course says its relatively low purchases of Greek and other governments' bond are nothing compared to the large QE programmes launched by the UK and US central; banks. But the ECB will none the less be very happy to offload the bonds as soon as it can, probably to the Luxembourg EFSF.
And if European governments are kind enough to allow the central bankers to make a profit (or at least avoid a loss) on the transaction, then the ECB, for one, will be delighted.
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