Home > Main > What do FX intervention “losses” mean to CB’s with fiat currencies?

What do FX intervention “losses” mean to CB’s with fiat currencies?

August 11, 2011

Current Market interventions are not that popular anymore – they’ve been steamrolled enough time by the markets to make central bankers wary.

But here’s a question – what do currency “losses” mean for Central banks who are working with their Treasury?   You’d think that people would ask this question a bit more now that it’s widely recognized that issuers of their own currency cannot run out of money.

What do “losses” mean to an entity that has the recognized power to create more currency at will?

Any sufficiently motivated Central Bank could simply keep selling their own currency without any solvency worries. Inflation worries, yes.  Solvency worries, no.

There might be political rules that prohibit the Bank from certain actions.  But from a purely economic point of view, “losses” due to FX market interventions are meaningless to the central bank.

For example, say the Bank of Japan (BoJ) decides to sell even more yen than they did a few days ago.  Everyone now realizes that sovereign governments can create any level of currency they desire.  The BoJ sells a bunch of Yen, gets a bunch of USD.

The BoJ might be usurping a fiscal function from the Treasury, but the traditional channel for FX interventions is the countries central bank.

Let’s say the yen rallies against the wishes of the BoJ.  So what?

It’s pretty widely accepted that the BoJ can make more money if it wants in this manner.  And it doesn’t have any reason to want to exit the trade.

All that’s happened is the BoJ’s balance sheet got bigger.

Then, let’s say they exit the intervention, and suffer massive losses. If they exit and get back only 50% of the yen they sold – so what?   Who is able to force a liquidation of any sort on the BoJ?  There isn’t an entity that can force this liquidation.

Then, let’s say the losses get realized for the BoJ.  What does this cause?  A some people will stop accepting yen from the BoJ?  Wouldn’t this be exactly what the BoJ wants?

We’ve seen this happen with China to a huge extent – they know they have the power of the currency.  But I think there is a widespread misconception that countries who’s currencies trade in the open market are largely immune to currency interventions.

This might be what’s happening in the Swiss with rumors of a peg. Phillip Hildebrand, head of the SNB is pretty smart and I bet he understands this.

Categories: Main
  1. Oliver
    August 12, 2011 at 5:01 am

    A market commentator here said the other day, after news that the SNB had suffered a massive loss last year, that, as a national bank, the SNB was not ‘really’ subject to the same kinds of constraints as other financial institutions. This put a smile on my face although I bet the significance of the comment was lost on most viewers.

    Seems the art of central banking nowadays lies in fathoming the degree to which irrational fears among the population can be circumvented through either secrecy or technical gibberish to be able to pursue a rational agenda, whereas the art of politics lies in tapping these same fears for short-term political gains. I.e. they’re moslty working against each other.

  1. September 6, 2011 at 10:38 am
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