|Weimar Germany during the early-1920s hyperinflation|
"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.