Let’s want a weak crown. The CNB launched a wealth fund

In the end, saving really didn’t pay off in the Czech Republic. Financial repression due to low interest rates and rapid inflation discouraged time deposits and bonds. The entrenched moderate inflation was perhaps still beaten by building savings. Whoever had the head and understood what was going on and what cheering inflation meant, ended up with term deposits and started looking for returns elsewhere.

He who saves has two

Houses and flats eventually became a hit during the financial repression. As an investment backed by cheap credit and an interest rate below inflation, this was a clear choice. Debt paid off, whoever does not owe robs the family. However, the whole spell of cheering 2% inflation, kicking employment by weakening the koruna, did not take into account shocks. The pandemic and the new war shuffled the cards.

Drahota, Czech inflation, which is breaking records in Europe. This is also a consequence of the CNB’s past policy. The koruna’s exchange rate is still affected by the policy of weakening the koruna. The package of foreign currency positions in the amount of 60% of GDP, which the central bank of the state still holds in its balance sheet, weighs on the koruna. This was called foreign exchange reserves, but also “foreign exchange investment tranches”, the wealth fund.

Over-indebtedness and indebtedness are the worst for shocks and shocks in times of crisis. There is no savings that can be relied on, and those who have savings are given unexpected inflation. And the giant debtor is actually the CNB itself, the central bank of the state.

Indebted National Bank

In the last decade, the CNB has invested in what the new CNB governor calls a “wealth fund.” Due to the operation of this fund, the management of this institution is ending repeatedly and will end in the red.

It is enough for the koruna to strengthen, and foreign currency positions in the wealth fund will be reported at exchange rates. The stronger the koruna, the greater the losses recorded in the central bank of the state.

But it is said that it does not matter, the economic losses are said to be accounting, virtual. The CNB, which has a monopoly on “printing” crowns, can also operate with negative capital. If necessary, he simply “prints” the missing crowns.

There seems to be no budgetary constraint in this institution. The loss of the CNB office is only an accounting item, it stands outside the state budget and the deficit management does not seem to burden anyone. As for the wealth fund, the “foreign exchange investment tranche” is a debt-financed fund. The CNB’s related liabilities, burdened by interest rate risk, are indeed gigantic. The CNB has borrowed and is borrowing from commercial banks to operate the fund and finance its foreign currency positions.

Yes, the CNB lent and pledged over two trillion crowns, which it issued. And banks now deposit all those crowns that are in surplus with the CNB at a decent interest rate.

Debt and wealth fund financing

Money on the Run, a website run by the CNB, asks readers the question: “Do you know how much money you spent last month?” It is about financing more than 2 thousand billion crowns. When the debt is calculated, in a country of ten million it is about 200 thousand crowns of liability per capita.

If the interest rate is 5%, then the CNB will pay CZK 110 billion (CZK 110,000,000,000) annually in interest on these two trillion crowns of its liabilities. But this is not a problem, the state budget does not burden it. There is no vote in parliament, the CNB, as the issuing bank, simply issues these crowns.

Let’s count on how much it is per month. If anyone would like to know how much money the CNB spent last month on financing its wealth fund, it amounts to about 916,666,666 crowns. For every citizen of a country of ten million, there is a hundred a month.

The question of where these newly “printed” crowns flow, how this relates to certain earnings for banks and the speculative derivative structures behind it, is another story. What is certain is that the wealth fund behind the CNB’s curtain is not operated free of charge, costs are accumulating and returns are more than uncertain.

Precisely because of the existence of its wealth fund, the CNB must scroll for transactions exceeding CZK 200 billion. It falls under repo operations, central bank transactions. And the cost of central bank transactions is a cost item facing the wealth fund’s returns.

Alleged wonders of investment banking

The central bank states that a significant part of the “foreign exchange investment tranche” is invested “forever”. Considerations about the operation of the wealth fund under the auspices of the CNB were also voiced by the CNB Councilor Aleš Michl, who was newly appointed Governor of the CNB. Michl expressed his visions in 2020: I want reserves, capital appreciation in the long run. And not get rid of him now. Being profitable. Understand my philosophy. I came from an investment banking and fund environment, said Michl at the time. He also highlighted his competencies: … I can build assets and I have learned that it is necessary to distribute dividends, earned interest.

Something was also said that the CNB could send “dividends to the budget”. The state will not be forced to issue more bonds and will not have to borrow more. What about the fact that the debts are borne by the central bank of the state itself and its management repeatedly ends in the red.

National Bank hedge fund

It may seem that the CNB is simply becoming a giant hedge fund, operated under the guise of secrecy and batoned by a majority of four votes of members of the CNB’s Bank Board. However, the words that such a fund can generate quite significant losses do not sound.

In reality, the CNB’s bond and other investments may not be as certain as they seem. There is a risk and a waiver of liquidity associated with every return. Solid bonds bear almost nothing in times of financial repression and have the potential to lose significantly in inflationary times. And even risk-free bonds of foreign governments carry their risk. With regard to geopolitical risks, the fact that the CNB’s wealth fund also lends to the Chinese government is particularly attractive.

If the CNB holds foreign government bonds in gigantic volumes in its investment fund, this will necessarily be reflected in the institution’s finances. It is gradually becoming clear that risk-free investments will not be able to cash in the proceeds and shares are also bought into the wealth fund. It is said that it is impossible to lose on them. And when the stock markets start to fall in price, it will only be a loss of accounting. Everything will be hidden behind the curtain of the central bank of the state.

There is no budgetary limit in the CNB, it will cover the virtual loss with virtual crowns. It’s the balance sheet of the sovereign, the issuing bank, it’s just an accounting item. And because it is outside the state budget, no one needs to care, no matter what the Czech Republic’s consolidated finances are.

Let’s want a weak crown and low rates

The CNB’s wealth fund’s foreign currency positions are also revalued depending on the koruna’s exchange rate. When the koruna weakens, these foreign exchange positions gain in price. The fulfillment of the CNB’s proclaimed vision of the wealth income fund can thus be supported by a skilful pro-inflationary monetary policy. All you have to do is weaken the koruna or push lower interest rates.

Especially in the case of a weak koruna and low interest rates, the wealth fund can even report a profit, no matter how badly invested and losses have occurred. It was at the time of the pandemic, when the koruna depreciated, that it was clear that the CNB had made a profit thanks to the revaluation of the foreign exchange positions of its wealth fund.

According to CNB Councilor Aleš Michl at the time, these were to be funds that could (despite the accumulated losses!) Be used in the fight against the pandemic. In March 2020, an article with the title was published in the national press Let the CNB send half of its profit to the state budget, calls on Michl.

It was an interview in which Michl defended that the accounting gain from the revaluation of the koruna’s exchange rate is the result of competencies in the field of “reserve management”: I want to use the money we made thanks to a great reserve management team, pronounced Councilor Michl.

As for the CNB’s potential profit, Michel’s thoughts have shifted recently. Not previously promised to pay the state in the event that the CNB’s operations will be profitable. The CNB must first cover its losses and replenish its reserve fund. In any case, the central bank of the state actually operates a wealth fund, which is in fact in conflict with the Constitution the required care for price stability.

Should the CNB operate a wealth fund?

Yes, other states also operate something like “wealth funds.” However, due to transparency, controllability and avoidance of conflicts of interest, it is a self-managed state sovereign wealth fund (SWF). Institutionally, it is clearly defined what such a state fund can invest in, how it is financed, who is responsible for it and how the fund manages.

The communication that foreign exchange reserves, gigantic foreign currency assets held by the CNB, an unwanted child weakening the koruna in 2013–2017, should be managed as a state investment fund took place in 2017.

In 2017, the Governor of the CNB Jiří Rusnok he said that large foreign exchange reserves were not a tragedy. In May, it was publicly announced that the government should buy part of the foreign currency assets from the CNB in ​​order to create an independent fund.

This would resolve the conflict of interest, ie the fact that the wealth fund would not be monetary-funded and non-transparent under the guise of banking secrecy of the central bank of the state. However, removing the investment fund from the CNB’s balance sheet encounters the need to finance this fund from the state budget.

In two months everything was different, the CNB decided on their wealth fund. In July, CNB Governor Rusnok announced that a new strategy was beginning. The central bank of the state has “to invest part of the foreign exchange reserves”.

The euphemistic notion of “foreign exchange reserve investment tranche” saw the light of day. The CNB started operating a wealth fund. When the amendment to the CNB Act was enforced last year, the state’s central bank was given the power to operate such a wealth fund by easing its powers.

The crown as Cinderella

The constitution states that the CNB, as the central bank of the state, should take care of price stability. The Wealth Fund is an unwanted child of the effort to weaken the koruna and cheer up inflation in 2013-2017. As a result, however, there is a dilemma. When there is a fous or two higher inflation in the Czech Republic and a weaker koruna exchange rate, the results of the wealth fund’s management will be better after the exchange rate.

If the new governor of the CNB communicated that the koruna has not been strengthening since 2008 and that interest rates may no longer increase since the summer, the question arises as to whether he is not considering the CNB’s wealth fund investment results.

If interest rates do not rise, the cost of financing this fund will not increase. Likewise, the weaker koruna will benefit from the results of the wealth fund’s investments. In reality, a conflict of interests or goals arises in the central bank of the state. To improve the performance of the wealth fund, it is enough to weaken the koruna and depress interest rates, but this increases inflation.