The Federal Reserve and its monetary policymaking counterparts worldwide have recorded enormous losses as they raised interest rates to combat inflation. Despite the sizable hemorrhaging showing up on the books, central bank chiefs do not believe it will alter how they conduct monetary policy.
The U.S. central bank is funded from the interest earned on its securities holdings, purchased from its open market operations to influence interest rates in the debt market.
Excess earnings are transferred to the Treasury Department, known as remittances. Between January 2011 and September 2022, the Fed sent Washington approximately $1 trillion in cumulative remittances. This helped the federal government pay some of its bills and plug a small portion of the gaping budget deficit.
For 19 months, the Fed has been deep in the red, accumulating about $1 trillion in unrealized losses. The Fed has suffered exceptional operating declines because it pays interest to banks to the tune of 5.5 percent, meaning the interest expense exceeds the interest income. When interest rates were near zero, these costs were minimal.
This also means that the Treasury is no longer receiving free money, with H.4.1 data showing the central bank’s totaled $151 billion in negative remittances for the week ending Feb. 21. As a result, the revenue stream for the Federal Reserve is erased and exacerbates the federal debt and deficits.
Research from St. Louis Fed Bank economists suggests that it could take close to four years for the central bank to recoup income losses and send profits to the Treasury again.
According to the New York Fed, the institution could begin sending profits to the Treasury as early as next year.
Until then, the Fed will avoid a fiscal catastrophe and avert panic on Wall Street because monetary authorities redefine negative liabilities as deferred assets.
“Once the Fed returns to earning a positive net income, it will pay down the value of the deferred asset until it reaches zero, at which point the Fed will resume sending remittances to the Treasury,” the regional central bank staff wrote.
“This deferred asset accumulates until the Fed sees positive net income, which should happen once interest rates on the long-duration assets it owns start exceeding the interest paid on bank reserves and reverse repo facilities.”
Fisher Investments staff likens it to “mostly imaginary red ink” since the Fed does not maintain capital requirements like commercial banks.
“A central bank isn’t a company. It can’t declare bankruptcy, it isn’t subject to bank runs, and it doesn’t have to worry about making creditors and investors whole,” the investment advising firm wrote in a note.
Peter St. Onge, a Heritage Foundation and Mises Institute fellow, says this “cute accounting gimmick” allows the Fed to avoid doing “the walk of shame.”
Monetary Trouble in Europe
Similar monetary trends are forming across Europe.The European Central Bank (ECB) posted its first annual loss since 2004. The source? Like the Fed, the ECB endured higher interest expenses on critical liabilities, and interest income on assets failed to keep up amid higher interest rates and long-term maturities.
ECB officials reported losses of $1.4 billion in 2023, and the final tally could have been higher, but policymakers released about $7 billion that the organization accumulated over several years.
The entity anticipated more losses in the coming years.
However, the ECB does not believe it will hinder “its ability to conduct effective monetary policy.”
“The financial strength of the ECB is further underlined by its capital and its substantial revaluation accounts, which together amounted to €46 billion at the end of 2023,” the ECB said in a statement.
“The loss, which followed almost two decades of substantial profits, reflects the role and necessary policy actions of the Eurosystem in fulfilling its primary mandate of maintaining price stability and has no impact on its ability to conduct effective monetary policy.”
In Germany, the Bundesbank reported net interest income of roughly negative $15 billion, the first time in its nearly seven-decade history. As the losses soared to around $23 billion, the German central bank’s risk provisions were wiped out.
Officials anticipate “the burdens to be considerable again for the current year.” However, they affirmed that these holes will not affect policymaking.
“The Bundesbank’s balance sheet is sound. The Bundesbank can bear the financial burdens, as its assets are significantly in excess of its obligations,” Bundesbank head Joachim Nagel told reporters at a Feb. 23 press conference.
The Dutch central bank suffered its first loss since 1931, totaling about $500 million. Like its counterparts, the De Nederlandsche Bank (DNB) is penciling in additional losses for the coming years, and the accumulative buffers could be eliminated.
“The higher interest rate ensures that the DNB pays more interest on the balances that commercial banks hold with DNB. While the income from holdings of government bonds, which have increased considerably as a result of the ECB’s purchase programmes, is not rising along with it,” the DNB said in a statement.
No Country for Old Yen
Japan is experiencing the same fate as others.The Bank of Japan’s (BoJ) unrealized losses on its government bond holdings have surpassed $71 billion as of the end of September 2023, the central bank confirmed late last year.
Bond prices have been pummeled by rising yields as they trade inversely.
BoJ policymakers are not too concerned because if the bonds are held to maturity, the paper losses based on market prices will not impact actual income volumes. At the same time, economists warn that abysmal central bank finances could trigger worries across financial markets, affecting the yen and interest rates.
The Japanese flag flutters over the Bank of Japan (BoJ) head office building (bottom) in Tokyo on April 27, 2022. (Kazuhiro Nogi/AFP via Getty Images)
Fitch Ratings economists say that the losses will not alter monetary policy in Tokyo, but its exposure to possible financial losses could worsen the government’s books.
“Even a relatively modest hit to the fiscal deficit could be significant for the sovereign rating given Japan’s fiscal path and debt dynamics, especially as it would occur at a time when the government’s interest costs are also rising,” the ratings firm said in a report.
This past summer, the Japanese central bank altered its yield curve control policy, effectively permitting long-term bond yields to climb to as high as 1 percent.
In November, the 10-year yield spiked to 0.965 percent, the highest level since 2012.