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Links: 2010-03-29 – Using central bank reserves as a slush fund

29 Mar

The first link is interesting. And too bad it is in Spanish for those of you who don’t speak English. It is an important piece about what happens when a central bank is not independent. 

The opinion piece from Argentine daily “La Nacion” points out that that country’s President Cristina Fernandez de Kirchner has demanded the central bank use its foreign reserves as a kitty to pay public debt maturities (Spanish language article from Clarin here). The problem with this, as Michael Pettis has pointed out, is that the reserves represent borrowed money.

…the PBoC has a balance sheet consisting on one side of dollar assets (and here “dollar” is short-hand for all foreign assets).   Against this and on the other side it has a roughly equivalent amount of RMB liabilities (I say “roughly” because when you run a mismatched balance sheet, changes in the relative value of assets and liabilities will create losses or profits).

Here is where things get interesting.  China’s reserves are often thought of as if they were a treasure trove available for spending.  They are not.  They are simply the asset side of the mismatched balance sheet.  If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet. – it would still owe the RMB that it borrowed originally to purchase the $100.  To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes.  Reserves are effectively borrowed money.

In January, Martin Redrado, the head of the Argentine central bank quit over this issue. What Cristina Fernandez de Kirchner is doing is inflationary. It is monetizing Argentina’s foreign debt by using foreign currency reserves (an asset) to buy up maturing debt by having the central bank print money (a liability) to balance the balance sheet. Her policy debases the Argentine currency and is the road to ruin.

An analyst said of the situation:

“Despite being independent on paper, in Argentina the central bank lost its independence over the past decade,” Segura said in a Jan. 22 telephone interview. “Redrado is responsible for that because he never stood up to the Kirchners until it was very late.”

Remember this as we watch the Federal Reserve’s own actions.

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