Why central banks can’t print money and what really happens

This is the common argument for what has happened in recent years. I can’t stand out here, I’ve often argued that way over the past year or two.

However, the narrative is wrong. Why this is so and what it means for our money and for us as investors:

What happens when we take our money to the bank

First of all, a “little thing” that many people do not know: If we take our money to the bank, the money is no longer our money. We then only have a claim against the bank. That means we can claim the money back from the bank in the future.

Most of us are used to it so far that it works smoothly. Therefore, the money in the bank feels just like our own money. Exceptions, however, confirm the rule, as for example customers of Cypriot banks were able to find out in 2013.

But that’s just by the way. What happens behind the scenes when we take our money to the bank and expect interest on it (which is only possible to a limited extent in the euro area)?

Financial planner and portfolio manager Steven van Meter explains it in very simple terms from the perspective of the US banking system. The bank has to somehow “generate” this interest. A lot of people think that by simply passing the money on, she does that.

In theory, that’s one possibility. However, this only works if the demand for credit is sufficiently high. (On the other hand, the bank doesn’t even need our deposits to do that, because it can simply create this money, but that’s an issue for another time.) On the other hand, if there is more money in the bank than borrowers can be found for it , she has to come up with something else in order to be able to somehow pay the interest on the deposits. For example, buy government bonds.

Depending on the expectations of how long the various deposits will remain in the bank, it can buy different government bonds with different maturities so that the repayments of the government bonds more or less coincide with the expected repayments of the deposits.

This is where quantitative easing (QE) comes into play

What happens with QE is that the central banks are now “buying” these government bonds held by the banks. In return, the banks then receive what are known as reserves from the central bank. These no longer have maturities such as government bonds. For the banks, these feel more like cash that pays interest – at least in the US. In the eurozone, banks have even had to pay interest for years for the privilege of maintaining these reserves.

However, this is not really a privilege. The banks cannot really do much with these reserves. Because reserves act as a clearing system between banks. However, banks cannot use reserves to buy other assets (such as government bonds again).

What the central banks are doing here has nothing to do with printing money

This QE process is described by many as printing money – and very often by myself in the past.

It kind of looks like that too. Because this process is what has caused the balance sheets of the central banks to explode in recent years. This makes it appear as if there is suddenly more money in the system. However, this is wrong.

As you can see from the description of the process above, money was never printed. The only thing that happens is that the central banks create new reserves that the banks receive in exchange for government bonds (or other securities).

This does not change the balance sheets of commercial banks by a single euro or US dollar. There is therefore exactly as much money in the system afterwards as before.

What do we investors do with this information now?

Now the question is, what does it all mean for us?

For me the most important lesson from all of this is that “our” money in the bank is not really our money and that behind this money is government bonds or other securities. In other words, in Steven van Meter’s words, referring to US banks, “Consumers have no idea that they are buying this stuff.” While only indirectly, it is.

What I also learned from this is that the narrative is wrong, that this money printing is responsible for the rising asset prices through the bank (stocks, real estate, cryptos, etc.), since QE does not change how much money is changed is in the system.

I would therefore be even less reliant than before that the actions of the central bankers will ensure that, on average, my assets will no longer fall in price in the long term.

Foto: AKSENTIY VOLODYMYR / Shutterstock.com

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