The controversy over the Lebanese central bank’s decision to record seigniorage as an asset in its crisis-torn balance sheet is no parochial matter. Across the world, strange things are happening to this important source of income for central banks and finance ministries.
Described as the profit made from printing money, seigniorage is the difference between the amount central banks receive on issuing money and the much lower cost of producing it, and the usually paltry interest paid to commercial banks on the reserves they hold at the central bank.
Seigniorage is a valuable asset, because issuing money and investing it in low-risk securities has always been a profitable business. Traditionally, central banks have treated the profits in accounting terms as an income stream rather than an asset. Yet putting a capital value on the discounted future income is not entirely outrageous. Indeed, it is odd that what is arguably any central bank’s most valuable asset does not appear on the balance sheet.
Provided that a central bank’s liabilities are not denominated in foreign currency and are not index-linked, the present value of seigniorage will always guarantee solvency. This is true even where, under conventional accounting, the central bank is lossmaking and showing a deficiency of assets against liabilities. Put another way, it can always print its way out of a solvency trap.
At the Banque du Liban, one snag is that seigniorage profits have been won at the cost of a catastrophic loss of confidence in the currency. Lebanon’s economic crisis has rocked the financial system, the government has defaulted on foreign debt and yield-hungry investors have turned tail and fled.
Steve Hanke of Johns Hopkins University, an authority on hyperinflation, estimates that inflation in Lebanon has been running at what he calls a sizzling 52.6 per cent per month. Since the monthly inflation rate has exceeded 50 per cent for 30 consecutive days, it now qualifies as a hyperinflation, he says.
A second snag is that the seigniorage asset that the bank has chosen to record on its balance sheet is completely illiquid. Finance ministries cannot cash in the value in a crisis by selling equity in the bank — too bad in the Lebanese case, where the government’s debt mountain stands at over 170 per cent of gross domestic product.
Another aspect of central bank profitability that entails an Alice in Wonderland approach to accounting is the biggest liability in the balance sheet, which is money. Yet to call this a liability risks what Winston Churchill called a “terminological inexactitude”. This lie is because, in a fiat system where the currency is not backed by gold or some other valuable asset, central bank money is irredeemable. While it is undoubtedly an asset of the holder, the holder cannot go to the central bank and demand that it pay up on its IOUs.
The significance of all this for the developed world concerns what is happening to the net present value of seigniorage more generally. For the big central banks, quantitative easing after the 2008 financial crisis caused seigniorage revenues to surge as they expanded their balance sheets. Meanwhile, the present value of the future income has soared because it is being discounted at ultra-low interest rates. The lower the rate, the higher the capital value.
Willem Buiter, former Citigroup global chief economist, has shown that with today’s levels of nominal and real interest rates, it is easy to arrive at infinite quantities for the net present value of future seigniorage.
This sounds like super-solvency, which would be very reassuring. But interest rates can go up as well as down, and one day they will. The climate of moral hazard surrounding the central banks’ unconventional measures since the financial crisis may receive encouragement.
Since 2008, the public sector and non-bank corporate sector’s borrowing has rocketed in the big economies. This underlines that the response to the financial crisis, and now the pandemic, continues the asymmetric monetary policy that has prevailed since the late 1980s. The US Federal Reserve has established a pattern of bailing out markets when they collapse, but failing to cap them when they fall prey to bubbles.
Meanwhile, through asset purchase programmes, central banks have joined in the search for yield that they themselves prompted, buying risky assets such as corporate bonds and, in the Bank of Japan’s case, even equities. We know they can print their way out of trouble. But a real risk is that what is left of their independence will be under threat when trouble next strikes, as it surely will.
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