(Mario Draghi, President of the ECB)
I have always aspired to establish my own business. Due to my background as a bureaucrat, it felt impossible. But now, I have finally decided to go for it. For anybody thinking of entrepreneurship as a way of life, the first question is always, what type of business? After going through various possibilities, I have decided on central banking as something that could be good for a guy like me.
I want to establish my own central bank, to help businesses and governments to operate smoothly and in a liquid environment.
As I worked my way through all the nuts and bolts of central baking, I realized that I had no idea of how central banks work out their balance sheets. A balance sheet is a rigorous way of doing accounting — it is something I’d need to do as a central banker — but how are central banks doing their accounting, if they can create money out of thin air?
Solving this thorny question took me a whole day. I will explain it to you.
Let’s first consider what a bank’s “balance sheet” is. A balance sheet is a way to trace everything a corporation possess into their legal owners. For example, to erect my central bank, I decided to inject some initial cash for its operations. I am considering injecting $100. True, this is not too much, but this will not be a problem because I can create money once the bank is operational. At any rate, my central bank’s balance sheet will show that the bank has $100 worth of cash as its “assets”, and it also has a “liability” of $100 to me, because I gave the money, so I own it. The assets and liabilities of a balance sheet must cancel each other out. In this case they do, because 100-100 = 0.
A central bank’s main function is to create money out of nothing, so how can I have a balanced balance sheet? How would I represent the infinite supply of money?
How do they do it, in fact?
My idea is to create $1,000,000 of new money at first, which would give me a total of $1,000,100 in cash assets. But assets and liabilities would not cancel each other out, because that one million is nobody’s liability. It came from nothing. This is the problem.
And because I can keep creating money, the balance sheet would get more and more “out of balance”.
After reading several scientific papers on central bank accounting, it was revealed that I need to put the new money into “liabilities” category!
To me the one million feels like jackpot, and not at all like a liability!
Consider a normal bank. If you deposit $100 into the bank, that money will appear as a $100 liability at the bank’s balance sheet. Why? Because the bank owns that money to you, obviously. You gave it to the bank in the hopes that you can withdraw it later. It will also show as a cash “asset” worth of $100, because the bank has the money in its vault. The bank can then lend it out for somebody, which would be another asset. Loans + collateral are an asset for a bank. (I am ignoring fractional reserve lending.) All this makes sense.
Central banks operate a bit differently. They don’t need money to have money: they create money. But like normal banks, this new money, according to the documents I consulted, will be a “liability” in the bank’s balance sheet. So once my bank is in operation, and I have created my first one million, my bank’s balance sheet would look like this (ignoring the initial $100):
Liabilities
one million (created from nothing)
Assets
one million (cash)
The balance sheet is indeed balanced. . . But if I create money out of nothing, to whom is it a liability to?
I understand that a regular bank owns the money to the depositors. But to whom will my central bank owe the money it creates? To God?
My business plan from this point on would be to spent the one million. Central banks like ECB buy bonds and stocks from the market, with the money they created. I, likewise, would buy, but perhaps a yacht and something nice. The balance sheets would then look like this
Liabilities: one million (created from nothing)
Assets: a yacht and other nice items, maybe a new car.
(My Peugeot is 2005 model and I could use a new car.)
Now obviously this would consume my entire capital, so I would need to create more money. This is not a problem at all for a central bank. It can create all the money it can think of. But the general idea of how it all keeps going is now clear:
Liabilities: whatever sum of money comes to mind, I create it.
Assets: whatever I want to buy, I buy.
And this, ladies and gentlemen, is central bank accounting secrets revealed. That is how it all operates.
It’s the modern day Sampo, the perpetual money machine from Kalevala.
This the way central banks have created trillions and trillions of new money as an extraordinary last resort measure to save our world from a looming economic collapse. They still do it, every month, week and day. Mario Draghi, the president of the ECB, just promised to keep the system going.
It has never tried before. We don’t know what will happen once it’s over. We don’t know where it is heading to. It’s what we researchers call an “experiment”. A gigantic experiment in free money creation, all around the world.
The central banks are saying that once “things look good”, they will reverse the process. What will then happen, if it ever happens, is that central banks will sell all the stuff they bought, and then the money they receive from the sales will reduce the liability side of their balance sheet. If so, the money will be destroyed, paid out to nothingness. It’s the exact reverse of creating money for nothing.
My central bank will definitely not do anything foolish like that. I want to increase my liability to nothingness forever. I happen to think that “liability to nothingness” is not a liability at all. It’s a bit like saying “Say ‘hello’ to nobody, he’s coming.” It’s just a play of words.
I suspect, like many others, that the central banks will never be able unload their huge portfolios back to the market. This is because if they tried, the markets would crash immediately. I therefore believe that they will keep buying. In the end, their balance sheet will look like this:
Liability: $4 quadrillion.
Assets: the world.
Finnish Syntax 