QE Underwater

British diplomat T.E. Lawrence once quipped: “The printing press is the greatest weapon in the armory of the modern commander.” But its value extends far beyond conflict. Central banks’ monetary printing presses allowed a decisive set of stimulus packages to be funded during the pandemic. Now, the printers are helping central banks sustain their operations.

Faced with a crisis, central banks around the world turned to quantitative easing: buying a great number of assets to ensure sufficient liquidity, especially in the market for government debt. As the banks loaded up on those sovereign bonds, they earned more and more interest income.

When most central banks earn a profit, it is paid back to their country’s treasury. The European Central Bank is an exception, paying its profits out to its members’ national banks. In 2021, the Federal Reserve had residual earnings of $107.8 billion, an increase of $19.3 billion from 2020. The amounts remanded to the Treasury reduced annual fiscal deficits.

The good times quickly came to an end this year as central banks curtailed their asset purchases, holding fewer interest-earning securities. Programs like the Federal Reserve’s reverse repo facility have been needed to absorb extra liquidity in markets, and their high utilization has led to higher interest expenses. And none of these fluctuations have any bearing on banks’ costs of operations.

The tide turned quickly. After remitting an average of $1.6 billion annually in the past decade, the Fed has fallen into negative earnings. Income for central banks around the world will keep falling as they exit their bond-buying programs and react to ongoing volatility in foreign exchange markets.

These losses do not include the effect of marking the central banks’ balance sheets to market. Bonds fall in value as prevailing interest rates rise. As of the third quarter, the Fed estimated its unrealized portfolio losses had exceeded $1.1 trillion—and rates have only risen since. Estimates for the Bank of England’s paper losses are £200 billion and counting. But as these banks hold most securities to maturity, these losses will not be realized.