A few days ago, an article in the Telegraph revealed that the Bundesbank, the German central bank, might require a taxpayer bailout due to losses incurred on its $650 billion bond portfolio. This situation could potentially be true for other European central banks as well. So, what led to this? In the eurozone structure, the European Central Bank (ECB) is responsible for making decisions on monetary policy and engaging in activities such as bond purchases, commercial bank supervision, maintaining stability, and managing the payment system. The ECB delegates some of these tasks to national central banks, including the buying of bonds to inject money into the economy. In the case of the Bundesbank, it was instructed by the ECB to purchase bonds in order to address the impact of lockdowns and stimulate the struggling European economy.
As I mentioned before, Europe’s economy is increasingly reliant on massive trillion-dollar stimulus packages that resemble Soviet-style five-year plans, but on a larger and faster scale. One of the key components of this perpetual stimulus is the asset purchase program, which was established following the near-collapse of Europe’s banking system a decade ago. This program operates similarly to quantitative easing, where central banks essentially create money out of thin air and use it to purchase assets, thereby injecting new money into the economy. While this leads to inflation and some economic activity, it is short-lived and requires continuous infusion. So far, the asset purchase program has resulted in the printing of approximately 3.2 trillion in assets. It’s important to note that these purchases were not made with the intention of generating profits; they were simply acquiring anything available. This is why being wealthy under a central bank regime can be advantageous: you can sell your assets at a high price and pass on the losses to taxpayers, as is the case with the Bundesbank.
The problem now is similar to what happened in the United States when aggressive interest rate hikes disrupted the equilibrium. Although the ECB didn’t raise rates as aggressively as the Federal Reserve, the approximately 3-3.5 percent increase over the past nine months compared to the Fed’s five percent hike is still substantial enough to cause losses and negative cash flow for central bank portfolios. Consequently, the Bundesbank is paying more interest to commercial banks than it’s earning from those bonds. Reducing rates is not an option since it would exacerbate inflation. Given that the eurozone is currently grappling with six percent headline inflation and has indicated further rate hikes, the losses incurred by national central banks are poised to increase. While these losses haven’t reached the scale of the Swiss National Bank, which suffered a loss of 141 billion last year due to monetary gambles in a country with a population of eight million, the ECB’s losses are likely to escalate rapidly.
Europe, like the United States, has cornered itself by printing an enormous amount of money during the COVID-19 pandemic. German voters never anticipated the possibility of the Bundesbank facing insolvency, just as Americans never thought the Federal Reserve could encounter such a situation. However, it appears that this is the new normal. We will continue to monitor developments closely. Until next time.
