Buiter on why the ECB as a whole can’t go bust
Citi’s chief economist and former BoE MPC member Willem Buiter is worried that the ECB’s new profit-and-loss sharing stance on National Central Bank asset exposures risks transforming the 19 NCBs of the eurosystem into a glorified currency board.
It’s a policy that also stands to bring needless uncertainty and volatility into the system. Making NCBs accountable for their own assets in his opinion only delays risk-sharing. If Europe is to defend its currency union there’s no way out of risk sharing in the long run. In fact, risk-sharing is precisely the point of a currency union. It’s what makes a currency union work.
According to Buiter the paranoia around risk sharing is also ill-founded. As he explained to FT Alphaville, in a consolidated state, the ECB balance sheet has a near infinite capacity to absorb capital losses.
As he put it:
On that basis, NILAC’s the only acronym you really need to care about. And even then, only if you’re worried about meeting inflation-indexed liabilities or losing market trust.
As Buiter explains, the reason why the Zimbabwes of this world went bust is because they had foreign currency liabilities and a non-finance-able real government deficit, and ran out of counterparties that were willing to lend to them in the open market.
In the eurosystem, the national central banks have only become vulnerable because of a lack of discretionary access to the printing presses.
From Buiter:
As long as they are willing to provide the credit, the game remains in play, says Buiter.
Furthermore, Buiter adds, the ECB can always theoretically sterilise the money creation by issuing ECB bills.
Eurozone: welcome to your currency board future - FT Alphaville
Buiter on soggy global growth in 2015 – FT Alphaville
Buiter’s now predicting Grexit probability of 90% - FT Alphaville
It’s a policy that also stands to bring needless uncertainty and volatility into the system. Making NCBs accountable for their own assets in his opinion only delays risk-sharing. If Europe is to defend its currency union there’s no way out of risk sharing in the long run. In fact, risk-sharing is precisely the point of a currency union. It’s what makes a currency union work.
According to Buiter the paranoia around risk sharing is also ill-founded. As he explained to FT Alphaville, in a consolidated state, the ECB balance sheet has a near infinite capacity to absorb capital losses.
As he put it:
The ECB can never be insolvent. The consolidated eurosystem, which legally doesn’t exist, could only go broke if either it had large numbers of foreign currency denominated or index linked liabilities which they don’t, or if they decide for some reason, should they make enormous losses, that they’re not going to issue enough base money to pay their bills because this would threaten inflation. So, only if they choose price stability over existence.The point, fundamentally, is that the ECB can always issue cash to pay off its euro-denominated liabilities, regardless of whether anyone wants the currency or not. In real terms the currency may, of course, take a hit, but insolvency really means not being able to pay your bills, which for as long as you control the printing press simply can’t happen.
But that wouldn’t be a rational choice, so I think basically the ECB, the eurosystem as a whole, effectively can’t go bust. But even if you impose the constraint, so that they too abide by their inflation mandate in the future, the stream of future seigniorage income they’re going to get under a two per cent inflation target and a reasonably modest two per cent real GDP target is still in the trillions. There’s a lot more, even Non-Inflationary Loss Absorption Capacity, which we call NILAC, in the eurosystem as in indeed in any central bank with a serious currency.
On that basis, NILAC’s the only acronym you really need to care about. And even then, only if you’re worried about meeting inflation-indexed liabilities or losing market trust.
As Buiter explains, the reason why the Zimbabwes of this world went bust is because they had foreign currency liabilities and a non-finance-able real government deficit, and ran out of counterparties that were willing to lend to them in the open market.
In the eurosystem, the national central banks have only become vulnerable because of a lack of discretionary access to the printing presses.
From Buiter:
The ECB becomes like a commercial bank board that pegs its currency to the euro. The currency board breaks down if there is a large withdrawal of reserves from the central bank that’s managing the currency board [i.e. when the central bank runs out of reserves]. But if the central bank is solvent, it should be able to borrow reserves, and meet any demand. It’s the same story if for a central bank that becomes insolvent, because it has demand for foreign currency outflows that it cannot meet, because its credit worth is in doubt and it cannot borrow anymore of the reserves, which is exactly what you would see in the euro area.Buiter makes the point that when you have the Fed, or the markets, providing the central bank of Argentina with the reserves they need to keep their system in check is no different to the Euro system’s 18 NCBs and the EBC providing the 19th central bank with credit through target2.
As long as they are willing to provide the credit, the game remains in play, says Buiter.
Furthermore, Buiter adds, the ECB can always theoretically sterilise the money creation by issuing ECB bills.
Anything that is not verbotten is allowed. So the fact that nowhere in the treaty does it say that you cannot issue even 10-year bonds or even 30-year.. I wish they would. I wish the ECB would do it because they would finally get a really risk-free curve for the euro. Because the ultimate risk-free eurobond issuance would be the consolidated eurosystem in the presence of full profit and loss sharing, or the ECB at the core.Related links:
Eurozone: welcome to your currency board future - FT Alphaville
Buiter on soggy global growth in 2015 – FT Alphaville
Buiter’s now predicting Grexit probability of 90% - FT Alphaville
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