Ben Bernanke Cannot Print a New Steve Jobs

Gold bulls rejoice, for open-ended QE is here!

Yesterday's Fed announcement wasn't the long rumored 'QE3', as a '3' implies a beginning and an end like the two prior rounds of quantitative easing.

The Fed has instead committed to not stop printing new money until the economy improves.

What then will the Fed do if the economy never improves, meaning unemployment never gets back below 5%? Will the Fed go on printing forever? We shall have to wait and see.

In the meantime anyone who believes that printing money ad infinitum will fix what ails the U.S. economy, or the global economy for that matter, is living in macroeconomic Willy Wonkaland.

Monetary policy in the form of printing new money and changing interest rates does very little if anything to improve the foundational competitiveness of an economy. The most dynamic economies are the ones which are the most productive and most innovative, and monetary policy has very little if any impact on these two areas.

The kind of GDP growth driven by purchases of products like Apple's iPhone reflects real economic growth. The kind of GDP growth derived from nominal GDP targeting (aka inflation) is fake.

In short, Ben Bernanke cannot create new real jobs. Real jobs are created by the Steve Jobs of the world.

However, it's much easier for central planners to punch a few buttons on a keyboard and print more money than to make the long-term adjustments necessary for fundamental economic improvement.

On the Topic of Financial Collapse Fear Mongering

"Ireland is in a death spiral" -FT

"After the November President election the U.S. is facing a fiscal cliff" -Federal Reserve staff

"Eurogeddon!" -The PolyCapitalist

On and on go the warnings of cataclysm and pending financial doom. Technical jargon and existential risks are bandied about in frightening fashion, leaving the general, less-economically literate with very little ability to understand what's actually happening or just how bad things could really get if say Greece leaves the Eurozone, or another country defaults, or something like this occurs.

This blog is not entirely innocent of this criticism, and this post is a brief attempt to quickly address the question of whether our global financial system is on the precipice of a financial collapse if say something 'really bad' happens in Europe?

The short answer is no.

Now before I expand on that answer I would like to clarify something very important: this post is about financial collapse and not about the extremely high levels of unemployment, which have reached approximately 50% for young people in countries such as Greece and Spain. The youth and general unemployment problems today are serious and something to be very concerned about. But this post is not about that but instead about whether another Lehman-style event could occur where the world's financial system risks implosion if say a country like Greece pulls out of the euro, the current 'bank jog' in Spain accelerates, etc.

So why isn't the risk of financial collapse as bad as some would have use believe?

For starters, we have to keep in mind that our financial world is a virtual world. Today, money is largely a set of numbers on a computer. This means that even in the most extreme scenario of financial disorder, where policymakers completely blow it and the ATMs stopped working and the stock market tanked, that everything that is real and tangible - the houses, the food that is farmed, the physical assets - none of this goes away and will all be here the next day when you wake up in the morning.

Now having said that, a financial implosion would definitely have a major impact on our lives, particularly for those with fewer resources or who are unprepared. But life will go on for nearly everyone and could actually rebound quite quickly given other historical cases. For example, Argentina began recovering within months following its utterly complete financial meltdown in 2001 even though the country achieved the relatively rare trifecta of a currency collapse, a banking crisis, and a sovereign default all at once. Iceland has had a relatively quick turnaround following its 2008 financial implosion. And other Asian countries in the late-90s also turned the corner pretty quickly following major financial crises.

In the case of Argentina, dozens of people died in Dec. 2001 riots, so I don't want to minimize the very real suffering and dislocation which comes with a financial collapse. But Argentina's experience is a far cry from the level of suffering of say a war or severe natural disaster. In short, a 'cataclysm', it was not.

A further point needs to be made about the above examples, which is that they were all relatively isolated, contained crises that did not threaten a systemic collapse in arguably the same way as the current crisis. But this leads me to point number two, which is that a systemic collapse is extremely unlikely, particularly given two facts:

1. what was learned from the recent Lehman-experience in 2008 by the current crop of policymakers.
2. the world's central banks, especially the Federal Reserve, still have loads of financial ammunition.

Regarding the first point, current policymakers got a first-hand glimpse of just how interconnected the world's financial system is and how the failure of a seemingly small cog in the wheel could threaten to topple the whole system. So while yes, Greece's financial implosion could lead to a chain reaction that threatens the entire global financial system, it is utterly inconceivable in the wake of the Lehman crisis that policymakers would sit back and let that happen given what they learned and how they responded in 2008-2009.

So I hear you asking whether all our problems are solved then because central banks like the Federal Reserve are all powerful, financially speaking, and able to contain any crisis which comes its way? Over the long-term, I would say no, they are not all powerful financially. But in the short-term, meaning right now and over the next few months at least, they are all powerful financially, and here's why.

Central banks like the Fed, ECB, Bank of Japan, and Bank of England which operate fiat currencies have an extraordinary power, which is that they can create an unlimited amount of money.

'Unlimited', meaning a truly infinite amount of money? Yes

What this means is that even if, for example, all the depositors in Spain and Greece withdrew every last euro from their local banks the ECB can supply all the notes that citizens want to hide under their bed mattresses. In short, the ATMs should never, ever run out of money in a fiat money system which is being managed by competent professionals.

But earlier I alluded to the fact that even though central banks can print an unlimited amount of money that they were not in fact financially omnipotent over the long-term, so what did I mean by that?

With the magic that is the computer a central bank could literally go and create and infinite amount of money. But there are side effects with central banks creating a lot of money, namely inflation. Without getting technical, simply put inflation is a rise in prices. Hyperinflation is a very large, sudden rise in prices.

But here is the crucial point to remember: rising inflation acts as a brake on a central bank's ability to create money. In other words, a rise in inflation is perhaps the key to understanding when central banks would be constrained in any effort to bail out the financial system.

Today, most of the world's advanced economies (North America, Europe) have relatively modest inflation, meaning low single digit annual percentage increases in official measures of core inflation. And even though they would say otherwise, the central banks in these advanced countries would be more than willing to trade an increase in inflation to stem the risk of a systemic financial collapse.

So how much more inflation would central banks be willing to tolerate as a tradeoff for not risking financial collapse? As the Bank of England has demonstrated in the past couple years, inflation creeping up towards 5% is not enough of a concern to prompt a significant deviation in policy. So my guess (it is a guess) is that at the extreme central banks like the Fed could tolerate up to 10% if they perceived the risks of collapse to be great enough before they would think twice about pulling another post-Lehman style bailout of the world's financial system. And since we're still in low single digit inflation this gives the Fed a decent amount of runway to maneuver.

This room to maneuver is what is meant when it is said that the Fed, which controls the world's most important reserve currency, and other central banks still have lots of ammunition.

The existence of this ammunition is likely a factor behind why given all the current distress in Europe that the stock markets haven't fallen further. In other words, the markets expect central banks to step in and flood the financial system with money if Greece leaves the euro or a banking run accelerates. Even the supposedly hemmed in by the Germans/hard-money crowd ECB. After LTRO and all the sovereign bond debt purchases, anyone who still thinks the ECB won't step in to save the system if things go completely pear shaped by creating a lot money is living in a fantasy. And this flood of central bank money would likely be very bullish for stocks in the short-term.

Should inflation increase significantly, then the ability of central banks to rush in and save the day could be diminished. But for now, they have the power to act, and that's why (for now) a general financial collapse is not on the immediate horizon.

So in sum, if you want to understand when it might be time to get worried, keep an eye on official measures of core inflation, particularly if it starts creeping up near the 5% level as that is about the time a proper central banker will begin to twitch over fears of runaway inflation.

Now, in terms of how you want to position your investment portfolio given the above, the very first post on this blog just over two years ago argued for allocating some of your portfolio into gold, which is arguably the best hedge against excessive central bank money printing. Even though the price of gold has gone up significantly in the last two years this blog still stands by that recommendation for long-term investors.

Greece Can Physically Print Its Own Euros In Spite Of ECB 'Choke' Efforts

Euro printing press

As the long ago predicted Greek 'bank jog' accelerates there is much talk in the econoblogosphere of the Greek banking system being 'choked off' by the ECB.

If this is in fact the Brussels/Frankfurt plan to force Greece out of the euro there is a perhaps not insignificant obstacle to this strategy: as noted in this post last year, Greece has its own euro printing press. 

The ECB does not print any euro banknotes but actually assigns this task to local member country central banks, with the ECB instructing the local central bank how much of which denominations to print.

So what does this mean?

In opinion polls Greeks want two things: a) to default on their sovereign debt less fiscal austerity and b) stay in the Eurozone. However, European elites (read: Germany) are saying to Greece that you can't have both. But is Germany correct?

An important point to keep in mind here is that there is no legal mechanism to force Greece to drop the euro and readopt the drachma. Hence the idea of choking off the Greek banking system and forcing the Greeks to renounce the euro versus organizing some type of formal action, such as a vote to eject Greece from the euro, which would not be allowed under current EU law.

But in the event of a full-fledged run on Greece's banking system, where Greek banks literally have no cash on hand to give to depositors, it would seem reasonable and (crucially) perhaps legal for the Greek central bank to start printing euro notes even if the ECB disavows this action.

If this were to take place is there anything the ECB could do to stop the Greek central bank from printing euros? Probably not.

It's hard to imagine the situation reaching a stage where the Greek central bank openly revolts against the ECB and starts printing euros. However, Greece need only hint at playing this card for it to have the desired effect, which is to force the ECB to continue accepting Greek bank collateral on reasonable terms. In other words, the fact the Greeks can print their own euros nullifies the ECB's ability to choke the Greek banking system into submission and force a 'voluntary' abandonment of the euro.

Your move, Angela.

2012 Prediction #3: The Gold 'Bubble' Will Not Burst This Year

George Soros has called gold the "ultimate bubble".

It's getting more than a little far along into 2012 to still be making predictions, but let me just state clearly that 2012 will not witness a collapse in the price of gold.

Why not? I've written about this at length previously, most recently here.

Gold is already off to a decent start in 2012, up $150/oz YTD, so it's perhaps a little unfair for me to be making this call in February. I'm also not making a call on whether gold will finish the year higher or lower, although I suspect higher. However, I am confident that we won't see the bottom fall out of the price of gold this year, or next for that matter.

Overall, we're somewhere in the middle innings of the fallout from the 2008 financial crisis and there is still way too much debt in the global financial system for the flight to gold to reverse.

As the Euro Rolls Over, Why Hasn't Gold Rocketed?

In early May of this year, with the euro hovering in the $1.46-$1.48 range, I disagreed vehemently with euro bulls such as portfolio manager Axel Merk who argued that the common currency was no longer vulnerable to a sell-off (see Merk's May 11 FT article titled 'Dollar in graver danger than the euro' and my counter arguments here, here, and here). 

Merk's argument was basically that in 2010, when the euro sank to a low of $1.18, the currency served as a proxy for the sovereign debt crisis. Now, however, investors were shorting sovereign debt directly and, according to Merk, recognized that it is a lot harder for the ECB to print euros than it is for the Fed to print dollars.

For awhile, as you can see from the below chart, it appeared that Merk perhaps had made a good point. From May the euro has shown remarkable resilience; for the last six months one sovereign after another has white knuckled its way through uncertain debt auctions and ever higher interest expense. Meanwhile the ECB kept its 'bazooka' semi-holstered with purchases of sovereign debt apparently capped at €20 billion per week. While the euro did soften from mid-May onwards it was able to keep it's head above the $1.40 mark for the summer and a good chunk of autumn.

Click to enlarge

Continue reading the full article at Seeking Alpha here.

Greece Has Its Own Banknote Printing Facility; Ireland Mulls Boosting Its

From the WSJ:

Most euro-zone central banks maintain at least limited capacities to print bank notes. While the European Central Bank is responsible for determining the euro zone's supply of bank notes, it doesn't actually print them. The ECB outsources the work to central banks of euro-zone countries. Each year, groups of countries are assigned the task of printing millions of bank notes in specific denominations. 

The countries have different arrangements for printing their shares of the notes. Some, like Greece and Ireland, own their printing presses. Others outsource to private companies. 

The assignments vary from year to year. Last year, Ireland printed 127.5 million €10 notes, and nothing else, according to its annual report. This year, it was among 11 countries assigned to print a total of 1.71 billion €5 notes.

Full story here.

Believe the Hype? Eurozone Collapse Fear-mongering Kicks Into Overdrive

Munchau gives the Eurozone at most 10 days to fix its problems before it implodes.

DeLong argues that "the Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash”.

But Johnson and Boone say such measures are basically pointless and have declared "The End of the Euro".

All of the above are respected thinkers with loads of experience and credibility, so clearly we are on the precipice of financial apocalypse.

But are we?

The Icy Silence

One country has taken a completely different path to the government and central bank financed bailouts urged by many of the Econoratti as the only way to save the Eurozone (and global economy) from economic catastrophe. That country is Iceland.

Iceland committed financial heresy when it decided to let its three formerly pygmy-sized banks, which rang up a remarkable $100 billion+ in losses, go bankrupt.

And how have things turned out for Iceland? So far, not too shabby.

Sound intergalactic advice

Iceland, an approximately $12 billion GDP economy, is small and none of its banks were Too Big to Fail. So it's an open question whether the example set by Iceland can be repeated by a larger country with a much more important banking system (i.e., Spain or Italy).

Having said that, one of the remarkable things about the current crisis debate is the near complete lack of contemplation of that very question. Instead an almost unanimous call is being made for the Germans to unleash the ECB money printing 'bazooka'. But that is just one of several different options.

As we contemplate Eurogeddon let's keep Iceland in mind. Contrary to what financial scaremongers would have us believe economic life does not come to an end when banks are allowed to fail and countries are allowed to go bust.

Eurozone Debt Crisis is the IMF's Responsibility, Not the ECB's

Marc Chandler hits the nail on the head.

The IMF, which is funded by other sovereign countries, was invented precisely for dealing with problems like the current Eurozone debt debacle. The IMF is the proper lender of last resort to sovereign countries, not the central bank.

Central bank lending to sovereigns often ends in debt monetization and hyperinflation. There are sound reasons behind German stubbornness against turning the ECB into a 'bazooka'.

More on this topic, including why the 'experts' with near unanimity are calling on the ECB rather than the IMF, here.

Video: Kyle Bass' Full BBC Hardtalk Interview

"Capitalism without bankruptcy is like Christianity without Hell" and other choice comments from the hedge fund manager profiled in Michael Lewis' most recent book, Boomerang.

h/t Zerohedge

Quote of the Day: On the Megabank-Government-Central Bank Axis

Portuguese President Anibal Cavaco Silva is calling for the ECB to go beyond just being a lender of last resort to banks and to become one for his and other European governments. Specifically, he's calling on the ECB to make "unlimited" purchases of EU sovereign debt. This may be the first time one of Europe's leaders has publicly asked the ECB to take this step.

Would such a move by the ECB be a sound one? From a recent editorial in the FT:

"If governments stand behind banks and banks stand behind governments and the central bank lends freely to both and also underwrites financial markets, then financial asset prices become completely detached from economic reality. In this “system”, the central bank implementing more quantitative easing is no different, in economic terms, from Bernie Madoff marking up his client accounts every month."

From 'Circular commitments lead to a Ponzi economy'.

More on the distinction between what is meant by being a lender of last resort to banks versus the governments here and why lender of last resort to sovereign countries is the proper role for the IMF.

Clarifying What Is Meant By 'Lender of Last Resort'

As the European debt crisis continues to worsen there are growing calls for the European Central Bank to purchase ever greater quantities of Italian and other troubled sovereign debt. Berkeley Professor Brad DeLong recently wrote a widely discussed piece arguing that the ECB is failing in its central banking duty as 'Lender of last resort'. But is it?

Professor DeLong makes some good points, particularly about the importance of establishing credibility with the market. However, he fails to differentiate between a central bank serving as a lender of last resort to the banking system versus a lender of last resort to sovereign countries. So far as I know (central bank operations are often murky by design) the ECB has continued to serve as the former but has resisted becoming the latter. There is a big difference between the two so this is an important omission by Professor DeLong.

With respect to the European banks, the ECB has opened and accessed U.S. dollar swap lines with the New York Federal Reserve Bank while also providing certain "unlimited" lending facilities to European banks. In short, the ECB is in fact playing the role of 'Lender of last resort' to Europe's banks. However, as DeLong notes, the ECB has only purchased European sovereign debt in limited quantities. How come?

The Germans get blamed for the ECB's spendthrift ways, with the not-so-distant memories of the Weimar hyperinflation still weighing on Teutonic minds (or so the usual armchair-Freudian analysis goes). But there is some prima facie evidence for this hypothesis: even though the ECB has (so far) not chosen to crank up the printing press full-bore two German ECB board members have resigned in the past year. The most recent, Juergen Stark, publicly stated that his reason for quitting was the ECB's resumption of Italian and Spanish sovereign debt purchases.

While the ECB may continue to hold back for now I suspect that if things get extremely ugly it will in fact print a much greater quantity of money than it has to date to bail the Eurozone out of its debt problem. If this happens euro bulls beware.

The other alternative is for the proper lender of last resort to sovereign countries -- the IMF -- to step in. The IMF was in fact created precisely for situations like the current Eurozone debt crisis. Given this you might be wondering why the experts, in near unanimity, are instead pointing towards the ECB? The answer, in short, is because the ECB has a printing press and the IMF (for now) does not.

Other countries, such as China, do have the funds to bolster the IMF to bailout Europe. But they'll want something in return, such as a greater voting share on the IMF's Board. This is an unappealing prospect to the U.S. and (in particular) Europe, which has since the IMF's inception held a perennial lock on the top job at the Fund. And so in the minds of many that leaves only the ECB.

Video: Niall Ferguson Says Financial Repression Preventing Full-Scale Italian Bank Run

Niall's latest comments on the Eurozone crisis after the jump:

The Italian Job: An 'Explosion in Slow Motion'

While much of the damage control attention in the rapidly escalating Italian crisis has fallen on the ECB's purchases of Italian debt, German Profressor Hans-Werner Sinn points out how the Bundesbank (and other European central banks) have been conscripted into lending a neighborly hand:

The ECB directed the central banks of all Eurozone members to buy huge quantities of Italian government bonds during the crisis. While the national central banks have not revealed how much they bought, the aggregate stock of all government bonds purchased rose from €74 billion ($102 billion) on August 4, to €165 billion this month. Most of this increase was probably used to purchase Italian government bonds. 

The German Bundesbank, which was forced to buy most of the bonds, strongly opposed the program, but was unable to stop it. In response, ECB Chief Economist Jürgen Stark resigned. He followed Bundesbank President Axel Weber, who had resigned in February because of the earlier bond repurchases. Meanwhile, the new Bundesbank president, Jens Weidmann, openly objects to the program, while German President Christian Wulff has publicly accused the ECB of circumventing the Maastricht Treaty.

Not to be outdone the Banca d’Italia has started printing money:

But the bond purchases are just the tip of the iceberg. Equally important, but largely unknown, is the fact that the Banca d’Italia has resorted to the printing press to cover Italy’s gigantic balance of payments deficit. The extra money printing and lending, as measured by the so-called Target deficit, effectively means drawing a credit from the ECB. 

This credit replaces the private capital imports that had hitherto financed the country’s net purchases of foreign goods, but which dried up because of the crisis, and it finances a capital flight, i.e. the purchase of foreign assets. The ECB in turn draws the Target credit from the respective national central bank to which the money is flowing and which therefore has to accept a reduction in its scope for issuing refinancing credit. 

Until July, only Greece, Ireland, Portugal, and Spain had drawn Target credit, for a combined total of €330 billion. Italy was stable and did not seem to need the printing press to solve its financial problems. No longer. 

In August alone, Italy’s central bank drew €40 billion in Target credit, and it probably drew roughly another €50 billion in September, when the Bundesbank’s Target loans to the ECB system increased by €59 billion (after a €47-billion hike in August). This is the highest Target loan ever drawn from the Bundesbank in a single month, and in all likelihood it went primarily to Italy.

Full commentary here. 

What is Money? (or How is Money Created?)

I just did a Google search on 'what is money?' and 'how is money created?', and many of the top results are probably confusing for someone looking for a simple explanation of the broader concept of money.

(Note: this post is not about physical cash or coin, which I trust most people correctly understand to be minted by the government. It is instead about a more complete measure of money in all its physical and non-physical forms: cash, coin, demand deposits, savings, etc.)

Courtesy of Dan Hind here's a simply explanation of how money is created:

Banks create money through the act of lending it. They don't have to limit themselves to lending out the money deposited with them. In fact, they can end up lending huge multiples of the money they hold in reserve. 

When they authorise a loan or extend credit in the form of an overdraft, the money is conjured out of nowhere.

So there you have it. Banks create the vast majority of the money supply out of thin air (electronic bits these days) when they make loans. Simple, right? Here's Dan again:

The economist and ironist JK Galbraith once wrote that "the process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent". Offered the unadorned truth, stripped of any technocratic flim-flam, we can scarcely believe it. It seems preposterous that money should have such humble origins, as though it is beneath money's dignity that it should begin life at a banker's keystroke.  

The truth about money creation is a bit like the end of The Wonderful Wizard of Oz, when it turns out that there is no all-knowing wizard, only an old man behind a curtain, making things up as he goes along.

A perhaps more interesting question is why the subject of how money is created is not taught in secondary school? The reason can't be that it's too complicated. But as one of the commenters on Dan's article notes:

 "it is truly preposterous how little the public knows about arguably the single most influential conception humanity has ever created."

Education Site: Educate yourself on various aspects of the financial industry with classes from accredited online colleges.

AEP on Euro Endgame: "Sorry Deutschland. History has conspired against you, again."

Evans-Pritchard on the Eurozone's Debt Endgame:

The Geithner Plan must be accompanied a monetary blitz, since the fiscal card is largely exhausted and Germany refuses to lower its savings rate to rebalance the EMU system. The only plausible option is for the ECB to let rip with unsterilized bond purchases on a mass scale, with a treaty change in the bank's mandate to target jobs and growth. 

This would weaken the euro, giving a lifeline to southern manufacturers competing with China. It would engineer an inflationary mini-boom in Germany, forcing up relative German costs within EMU. That would be the beginning of a solution, albeit a bad one. 

Sorry Deutschland. History has conspired against you, again. You must sign away €2 trillion, and debauch your central bank, and accept 5pc inflation, or be blamed for Götterdämmerung. It is not fair but that is what monetary union always meant. Didn't they tell you?

Full article here. 

Video: Jim Rogers on Greek Default, Operation Twist, SNB Intervention & Why He's Shorting Equities

Rogers on how "Bernanke has been lying to us again" and other thoughts on what's happening right now and where he's investing.

End Game: Greece to Default This Weekend?

While the Greek government is publicly denying it (I suppose they have to until the banks close) the game appears to be up (further confirmation from Spiegel here).

The timing of the default would come roughly in line with my prediction. We're also seeing a softening in the euro, now down to $1.36, also as predicted.

In terms of what happens next, the first step following default would likely be a bank holiday in Greece. This would then be followed by some type of devaluation (rumoured to be around 50%) of the reintroduced drachma.

As I posted yesterday, anyone in Greece who still has their euros in a Greek bank may want to move swiftly.

Here is Professor Eichengreen with some deeper perspective and why its likely the ECB is going to be doing a lot of Ctrl+P.

SNB Gift-Wraps $2,000/oz. Gold

Perhaps not since World Bank President Robert Zoellick publicly advocated a return to the gold standard last year has the barbarous relic received such a sure-fire price boost.

Today the Swiss National Bank declared that it will print an "unlimited" number of Swiss francs (because fiat central banks can do that) to prevent further appreciation of the franc.

The Swiss franc had been considered perhaps the ultimate safe haven currency, alongside perhaps to a lesser extent the Japanese yen. Both have been appreciating steadily over the past year+ in the face of periodic interventions by their respective central banks. Both countries have trade surpluses, which creates a built-in demand for their currencies as domestic firms repatriate funds. The Japanese and Swiss banking systems are also considered relatively strong. However with the SNB's decision to crank up the printing press and peg the franc to the euro at 1.20 francs will undoubtedly increase pressure on the Bank of Japan to do something similar.

Strangely, the price of gold dropped dramatically on the SNB news before rationality returned and pushed gold back up to an all-time record high of $1,923/oz. (although it did finish the day below $1,900).

Bottom line: today's news is very bullish for gold, and my prediction, made just under a month ago when gold reached $1,700/oz., that the yellow metal would push forward to $2,000/oz. should now materialize sooner than anticipated.

Keynes on Printing Money, and Do Loss-Suffering Central Banks (i.e., ECB, SNB) Need Capital?

Weimar Germany during the early-1920s hyperinflation

A 1924 quote from John Maynard Keynes reflecting on events in Weimar Germany and Lenin's Russia:

"A government can live for a long time, even the German Government or the Russian Government, by printing paper money." 

However, "In the last phase, when the use of the legal tender money has been discarded for all purposes except trifling out-of-pocket expenditure, inflationary taxation has at last defeated itself."

The above quote was excerpted from a 1997 paper by the IMF's Peter Stella titled 'Do Central Banks Need Capital?'

Can Central Banks Go Bust?

Technically speaking, the answer according to Stella is no, central banks do not require a capital buffer to absorb losses in the same sense that a commercial bank does. However, Stella states:

"Weak central bank balance sheets invariably lead to chronic losses, the abandonment of price stability as a primary policy goal, a decline in central bank operational independence, and the imposition of inefficient restrictions on the financial system to suppress inflation. 

...if society values an operationally independent central bank capable of attaining price stability without resorting to financial repression, the transfer of real resources to recapitalize the central bank becomes necessary when chronic losses are sizeable."

In other words, the overarching reason for central banks to hold sufficient capital is that it helps maintain confidence in the soundness of the central bank and the value of the currency it issues.

Has the ECB Become Europe's 'Bad' Bank?

As the European debt crisis has spread and intensified, central banks in Europe have been suffering heavy losses for over a year now.

The Swiss National Bank has reported losses in the tens of billions of swiss francs on its euro purchases over the past 12+ months. Whether or not the Swiss government will move to recapitalize the bank is unclear. So far as I know the Swiss central bank is unique among major world central banks in that it is publicly-traded with both government and private shareholders.

There has also recently been speculation that the relatively thinly-capitalized European Central Bank will need to be recapitalized again if it were to continue to suffer heavy losses on its purchase of European sovereign debt. The ECB recently began purchasing tens of billions in Italian and Spanish debt, which comes on top of the tens of billions in Greek, Irish and Portuguese debt it already holds. The prospect of the ECB needing additional funding is not sitting well with Germany and other rich European nations which will have to foot the bulk of the bill.

Interesting times in the world of central banking.

Video: Raise the Debt Ceiling Rap

A little late to spot this one, but it's well done and will be relevant again in a few months time when the debt ceiling vote comes up again.