Rich world central banks on new ground
Over the years, the central banks of the rich world have become one-trick ponies. They print and flood the financial system with money to drive down interest rates at the slightest sign of trouble in the economy. The hope is that at lower interest rates, people will borrow and spend more, businesses will borrow more and grow, and in doing so, economic growth will be restored.
To flood the financial system with liquidity, central banks print money and buy government and private bonds, thereby increasing their total assets.
As can be seen from the attached chart, the total assets of the US Federal Reserve were between $700 billion and $900 billion in the years leading up to 2008. In mid-September of that year, the global financial crisis started with investment bank Lehman Brothers. bankruptcy and the world’s largest insurance company, AIG, to be nationalized. Many other major financial institutions also had to be bailed out by rich world governments and central banks.
To ensure that the US economy did not slide into a depression, the Fed began printing money and injecting it into the financial system by buying bonds. As a result, its total assets began to rise, peaking at $4.5 trillion in 2014.
In late 2019, the Fed resumed printing money and buying bonds, even before the covid pandemic hit. As of April 13, total assets had grown to around $9 trillion.
Interestingly, the gross domestic product or size of the US economy on July 1, 2008, before the full-blown financial crisis erupted, was $14.9 trillion. More than 13 years later, on October 1, 2021, the size of the US economy was $24 trillion (in nominal, non-inflation-adjusted terms). This means that the US economy grew by 61% during this period.
At the beginning of July 2008, the total assets of the American Fed amounted to 900 billion dollars. By early October 2021, they had jumped to $8.5 trillion, more than nine times. Ideally, the size of a central bank’s balance sheet should increase with the size of the country’s economy. Obviously, that didn’t happen. This is also visible in the case of other central banks in the rich world.
Take the Bank of England. As of July 2008, its total assets stood at £94 billion. It grew to over £300 billion in 2015. Currently it stands at around £1 trillion. The size of the UK economy has grown by around 45% between 2008 and 2021. Even in the UK, total central bank assets have grown much faster than the economy as a whole.
All that printed money floating around in the financial system has led to bubbles in the stock, real estate, and crypto markets. It has also resulted in unprecedented ten-year inflation in recent months.
Therefore, central banks in the rich world now want to withdraw the money they had printed and injected into the financial system by gradually selling off the bonds they have accumulated on their balance sheets over the years. The Bank of England has already started to do so. The US Fed plans to withdraw up to $1 trillion this fiscal year by selling bonds.
Nonetheless, these are uncharted waters, with central banks expanding their balance sheets for nearly 14 years now. No one really knows the impact of this. Will this lead to interest rates rising too quickly and too quickly, triggering an economic recession in a world still trying to recover from the aftermath of the pandemic? Will this ultimately lead central banks to stop the withdrawal of printed money from the financial system? On that, your guess is as good as mine.