Can Central Banks Monetize Foreign Government Debt?

Discussion in 'Economics' started by achilles28, Feb 16, 2010.

  1. achilles28


    The FED can monetize debt issued by the US Treasury (Government).

    Can the FED also monetize debt issued by foreign central banks? Say the BOJ or ECB?
  2. Not directly, but, as discussed elsewhere, anything is eventually possible (not probable) due to the substitution effect.
  3. achilles28


    Maybe. The article says the FED accepted toxic agency debt from foreign central banks in exchange for T-bills (risk-free debt). Basically, transferred toxic risk off US banks and, apparently, foreign central banks, onto the balance sheet of the FED.

    I guess what I'm driving at is how did those foreign central banks finance the purchase of US agency debt? Or, in other cases like China, Treasury debt?

    Was that money generated by legitimate tax revenue, remitted to central banks, and used to purchase T-bills, for instance? Or was it simply created out of thin air, then used to purchase US debt?

    I've often wondered about this. Seems over the past decade, Government bond markets haven't reflected real inflation or market risk. Bonds were a reliable economic bell-weather not so long ago. Now, they've all but decoupled. When FED T-bill purchases are considered, their ownership stake hasn't increased dramatically. Similar to other Central Bank portfolios for their respective government debt. This leads me to suspect that the FED and other Central Banks could be monetizing each others Government debt, to maintain the illusion of confidence. The only limiting factor would be an exchange rate crisis, but, if coordinated proportionately, fx rates would remain in their bands, but progressively erode against commodities. It just makes sense when I think about it. It costs Central Banks nothing, FX rates very little, and greases investor confidence in global and domestic economies.

    I don't know. Maybe foreign monetization is prohibited in a Central Banks charter? But on the other-hand, how would anyone know outside of the Central Bank that does it? That's my point. There's no way to know if a Central Bank is monetizing another countrys debt except via exchange rate values.
  4. How is Freddie/Fannie/FHLB debt/MBS more toxic than T-bills, given that the GSEs enjoy an unlimited explicit guarantee from the US Treasury?
  5. achilles28


    The zerohedge article nutmeg posted implied foreign central banks were exchanging agency debt for treasuries. Here's the source article where both the swap of agency debt and "check kiting" is discussed:

    International check kiting

    Some people view the custody account as nothing more than an elaborate version of check kiting, played at the central banking level.

    Check kiting

    An illegal scheme whereby a false line of credit is established by the exchanging of worthless checks between two banks. For instance, a "check kiter" might have empty checking accounts at two different banks, A and B. The kiter writes a check for $50,000 on the Bank A account and deposits it in the Bank B account. If the kiter has good credit at Bank B, he will be able to draw funds against the deposited check before it clears, i.e., is forwarded to Bank A for payment and paid by Bank A. Since the clearing process usually takes a few days, the kiter can use the $50,000 for a few days, and then deposit it in the Bank A account before the $50,000 check drawn on that account clears.

    In this game, Central Bank A prints up a bunch of money and buys the debt of Country B. Then the central bank of Country B prints up a bunch of money and buys the debt of Country A.

    Both enjoy the appearance of strong demand for their debt, both governments get money to use, and nobody is the wiser. Except that the world's total stock of central bank reserves keep on growing and growing and growing, as reflected in the custody account, which will someday result in thoroughly unserviceable amounts of debt, an unmanageable flood of money, or both.

    If this strikes you as a scam, congratulations; you get it.

    If that was all there was to the story, then it would be far less interesting than it actually is. When we dig into the custody account data, we find that the total picture is hiding something quite extraordinary. Even as the total custody account has been growing steadily and faithfully, the composition of that account has been changing dramatically.

    Here we note that agency bonds peaked in October of 2008 at nearly a trillion dollars but have declined by $178 billion since then. Treasuries, on the other hand, have increased by over $500 billion over that same span of time. A half a trillion dollars! If you were wondering how the US bond auctions have managed to go so smoothly, here's part of your answer.

    What is going on here? How is it possible that central banks are buying so many Treasury bonds, at the fastest rate of accumulation on record?

    It would appear that foreign central banks have been swapping agency bonds for Treasury bonds, but that's not how the markets work. First, they would have to sell those bonds, before they could use the proceeds to buy government debt. So to whom did they sell those Agency bonds in order to afford the Treasury bonds?

    Here we might recall that the Federal Reserve has been buying agency bonds by the hundreds of billions.
  6. I have read both the ZH and the Chris Martenson article, achilles. There's too many factual inaccuracies in both and much of the logic doesn't make sense, but I am really tired of incessantly arguing with crackpot conspiracy theories. As I mentioned in another thread, before discussing the secret international Fed cabal, I want someone to conclusively prove to me that Britney Spears isn't a space alien.

    As to my comment, I was only suggesting that describing agency debt/MBS more toxic than treasuries is incorrect. In terms of counterparty risk, their respective toxicities are exactly identical.
  7. achilles28


    I hear you. We're arguing hypotheticals since the data on swaps is incomplete. Foreign Centrals banks hold more T-bills and less agency paper. Whether the FED swapped those outright is the question mark.

    But, to indulge you, why dump agency paper if the guarantee is the same? Agency debt will get thrown under the bus before Treasuries do, in the event of a US debt-restructuring/default plan, which isn't too far down the road. Same reason why Sovereign wealth is moving to short dated maturities and abandoning the long end. Market knows there's long-term risk with US debt. Same theme.
  8. The dumping of agency paper makes a lot of sense, if you look at the amazing tightening of mtge spreads (obviously, that in itself is a result of Fed's activities). Here's what happened and I don't blame the holders of agency MBS for wanting to take profit:
    (this is a plot of Fannie 5s LIBOR OAS; long MBS positions are short that)

    As to the long-term risk of US debt, the issue is complicated. The mkt doesn't just trade on the basis of default/credit views. The shape of the curve matters also and, who knows, maybe the Fed does tighten after all. In that case, being long the front end could be a somewhat painful trade.