This week has seen a flurry of activity at the ECB or European Central Bank and I do not mean the usual “sauces” which have been raising some doubt about a further reduction in the monthly flow ( currently 30 billion Euros) of QE bond purchases. Let us open with some Brexit bingo from the Financial Times.
Brussels is considering a €56bn raid on European Central Bank profits to plug a hole in the EU’s long-term budget after Brexit. The European Commission will discuss the plan at its weekly meeting on Wednesday, where it is due to consider a range of new revenue sources as it tries to maintain its financial firepower once the EU’s second-biggest net budget contributor leaves the bloc in 2019.
There is some debate over whether the UK will be the second or third largest net contributor but you get the message. We also get a clear sign of the bureaucratic mind which of course wants more revenue rather than cutting spending in true Sir Humphrey Appleby style. But why not simply get the money from the usual sources ( minus one)?
The commission is considering an ECB cash raid as a quick way to generate money for the common EU pot as several wealthier members, including the Netherlands and Austria, refuse to raise their contributions to the €1tn EU budget after the UK’s departure.
Okay so as they do not want to pay how would it raid the ECB?
The ECB proposal would divert profits made by the eurozone’s 19 national central banks from printing banknotes straight into EU coffers. The commission estimates the revenue stream could generate €56bn during the seven-year span of the next EU budget.
No doubt more than a few of you have spotted what Shakespeare would call the rub here but let me explain.
This is the profit from issuing money which comes from the fact that if we take the example of the picture of the 50 Euro note it costs a lot less than that to make one. So as it comes off the printing presses hey presto there is a large profit, or rather when someone wants it there is. From the ECB.
They make their way to you via your bank, which pays the face value of the notes to the central bank. To do this your bank usually needs to borrow money from the central bank or it pays by handing over some of its assets. The central bank earns interest on the money it lends, or receives a return on the assets it acquires – and this is called seigniorage income.
To give you an idea the US Federal Reserve calculates it costs some 12.9 cents to make each US $50 note so the note is almost “all gravy” to coin a phrase. A little care is needed as smaller denomination coins actually make a loss – hence the campaigns from time to time to get rid of them – but overall the operation is extremely profitable. However you may note that it is not the capital profits under discussion here ( that presumable can wait for a more desperate time) it is the income from them.
Is anybody else thinking that the campaign to get rid of the 500 Euro note might now have a rethink? Kenneth Rogoff might go from hero ( of the establishment) to zero overnight.
But then we hit a rather large stumbling block.
Although the ECB does not physically issue banknotes, it has been agreed that of all the banknotes in circulation in the euro area, 8% – in terms of value – are considered to be issued by the European Central Bank. The national central banks put the notes into circulation on the ECB’s behalf, and the ECB earns seigniorage income on the 8% through the claim it holds on the national central banks.
Okay before we break that down let us have a break for some humour. From kim in a comment to the FT article.
The ECB takes a cut of the transferred seignorage, to pay for its Christmas Party.
But the 8% is a gift as you see the income goes to the central bank which is each national one. Oops!
Danger! Will Robinson Danger!
There are consequences here and let me take you back in time to explain them. Let me illustrate from the Maverecon Blog of my tutor from back in the day Willem Buiter from 2009.
The NCBs that own the ECB themselves have a range of formal ownership arrangements, but
are ultimately under the financial control of their national fiscal authorities, because the
national fiscal authority can always tax the NCB.
So we are back in a way to how this story started because the money belongs to the national governments via their treasuries or if you consider belongs to be over playing it they can at least take it via taxation. It is not usually expressed as taxation but we regularly discuss payments from central banks to national treasuries as part of QE declared profits. Most of us would love to be able to declare something “independent” then sing along with the Steve Miller Band.
Go on take the money and run
Go on take the money and run
Go on take the money and run
Go on take the money and run
We of course would sooner or later end up in jail unless we had the wisdom to set up a bank ourselves. But then looking back to 2009 there is this that strikes to the core of the ECB itself.
What makes the ECB more independent than any other central bank is the fact that it has 16 national Treasuries as its counterparties rather than a single national Treasury. Should a European fiscal federal authority ever emerge, the anomaly of the ECB as a de facto as well as a de jure financially independent central bank would probably come to an end.
There are of course some extra treasuries now so it should be even more independent and yet seems set to lose it. My argument with my old tutor would be that politicians are pretty much the same the world over so the situation has always been more like the episode of Star Trek where the USS Enterprise is swallowed by a giant amoeba in my opinion. Of which this is simply the latest step. It should not be true under the rules of mathematics but we know that in human behaviour more can sometimes be less.
Actually there is a problem here too as the ECB notes.
Seigniorage income has been falling since 2008, in line with a decline in euro area interest rates.
Let me make that clearer because you see at the moment their isn’t any because the current account rate is a grand 0%. Actually contrary to the forecasts above the ECB under Mario Draghi seems in no hurry to raise interest-rates so they could be there for a while and may well survive his term as ECB President. If a recession hits they could cut interest-rates again in which case the European Commission will have shot itself in the foot.
There are several issues here which go to the heart of an “independent” central bank. Up until now it has operated in concert with the establishment where lower interest-rates and QE have generated gains for the establishment. But the irony of the European Commission proposal would be that it would lose if the ECB cut interest-rates again as seigniorage income would be negative. So suddenly we might find that they are keen on higher interest-rates which is quite a tangled web! It might have been far better if the subject had remained in the text books.
Also there are national issues as some national central banks issue more cash that others under the ECB system. We find ourselves quickly returning to yesterday.
The value of accumulated net issuance of euro banknotes by the Bundesbank rose between the end of 2009 and the end of 2017 from € 348 billion to € 635 billion. Since 2010
On average, the Bundesbank gave an average of € 35.8 billion in euro banknotes a year.
This corresponds to an average annual growth rate of 7.8%.
Or we can put that another way as Lorcan R Kelly does here.
The Bundesbank has, since the introduction of the euro in 2002, put a net 327 billion euros into circulation above its on-paper allocation………In total, 592 billion of the 1.1 trillion euros worth of banknotes in circulation at the end of 2016 started life at the Bundesbank.
The ECB explains this by giving an example of German tourists spending money abroad whereas I am sure I am not the only person who remembers the phase where people were worried about the Euro and therefore keen on “German” Euros as opposed to in the worst case “Greek” ones. Also should interest-rates rise there is a cost as you have to pay if over your allocation.
Should the ECB, over time, raise benchmark interest rates to 2 percent, for example, that would impose an annual cost of 6.5 billion euros on the Bundesbank.
So a transfer to the European Commission what could go wrong. Also if we note that this seems to be something under the aegis of Mr.Juncker he might be able to help out with this.
One more thing worth noting from the data is the position of Luxembourg’s central bank. It has an allocation of less than 3 billion euros and yet has put over 96 billion euros into circulation, and in this case it doesn’t seem like holiday makers are to blame.
So as a final thought is the US Federal Reserve planning a Seigniorage party with its interest-rate rises?