We are finally heading towards the end of this fateful year 2022, a super complete year for our investment training, full of strong emotions from the beginning to the end. This year's bear market has been marked mainly by the war in Ukraine, which caused the energy crisis that has us all in suspense, which has led us to unsustainable levels of inflation. Although inflation seems to have put on the brakes, we do not yet know if it is going to start going down or whether it is going to gain more strength and continue rising. The future of economies is in the hands of central banks. So, we are going to dedicate today's investment training to talking about central banks, how they work and which ones are the main ones.
What are central banks?
Let's start this investment training by first defining what a central bank is. Central banks are financial entities that are responsible for the management of their corresponding local currency. At the same time, they are also responsible for the design and implementation of the monetary policies of a state or an economic region. In simple words, they are centralized autonomous institutions that have certain privileges, basically they are the bank of states and commercial banks. These entities do not act in the same way in all countries or regions, since the relationship between central banks and government entities may differ depending on the country or region established. They maintain their sovereignty and neutrality in political matters. At the same time, they are not affected by the movements or decisions of investors, as happens in private banking entities, which is why they are not influenced by market forces.
What are the functions of a central bank?
Now that we know a little about what these financial entities are, let's continue the investment training by seeing how they perform their different functions. Mainly its objective is to maintain inflation close to 2% annually through certain functions:
Control and issuance of foreign currency.️
Central banks enjoy the privilege of having a monopoly on the control, management and issuance of the local currency. They are in charge of the distribution of the currency in the markets, from a country to an entire region as is the case we have in the euro zone. In coalition with this function, it should be noted that the European Central Bank (ECB) manages these operations with the central banks of each country belonging to the eurozone.
Interest rate policies.➗
El event catalyst par excellence of this year 2022, which we have discussed numerous times in other investment training articles. These policies are responsible for controlling the supply of capital in the market through the application of interest rates. These directly affect the cost of money and the prices of capital lent by central banks to private banks (commercial banks) and the interest rate they will receive on bank deposits. With the application of these interest rates, private banks establish their interest rate policies towards the public, such as mortgage loans and savings accounts.
Open market operations.
Another of the functions (poorly applied) that we have witnessed during these years is the purchase and sale of financial assets in secondary markets. Through this type of operations, central banks inject liquidity (expansive monetary policy) or reduce the supply of capital in the markets (restrictive monetary policy). As we saw during the pandemic, central banks decided to buy state bonds, expanding the money supply in said countries or areas to boost economies in the face of the economic crisis. devastating economic effects of Covid.
Interest rates applied to reserves.️
The capital provided by central banks to private banks has certain conditions, including the obligation to maintain a percentage of the capital they receive from clients as collateral. These rates applied to reserves are determined by central banks. In this way, it is possible to have control over the amount of capital in circulation, making it possible to withdraw capital from the market to cause increases in its value, making it more scarce.
Management of official reserves.
Unlike the cryptocurrency sector, which has been greatly impacted by the lack of transparency in FTX exchange reserves, central banks intervene in the Forex market when managing the reserves of a country or region with foreign currencies. These reserves are made up of assets such as government bonds, foreign currencies, securities and precious metals. These official reserves serve as coverage for the payment of the debts of the countries/regions and their financing. In turn, they allow you to influence exchange rates with the trading of foreign currencies with the aim of maintaining the value of the local currency.
Which are the most important?⚜️
Now that we have reviewed what central banks are and what their main functions and characteristics are, let's continue the investment training highlighting the most important central banking entities globally:
US Federal Reserve (FED).
The United States Federal Reserve, popularly known by the acronym Fed, is the entity that acts as the central bank of the United States. It was established on August 10, 1914. Par excellence, it is the entity that has the most impact on all global economies, given that today the US dollar (U$D) continues to be the most used currency for commercial transactions. Within this entity there are councils of governors from different regions of the US, which are appointed by the president of the government in charge and validated by the Senate. Its current president is Jerome Powell. Currently the interest rates applied by the Fed are at 4%.
European Central Bank (ECB).
The European Central Bank (ECB) is the synonym of the Fed in the old continent. This entity is in charge of managing monetary policies in the euro zone (€). It was founded on August 1, 1998. This entity is made up of six members of the executive council of the ECB, together with the governors of the central banks of the countries that make up the euro zone. They usually meet every two weeks, giving public appearances every month to announce changes in policies or analyze the context of the economy. Its current president is Christine Lagarde. Currently the interest rates applied by the ECB are 2%.
Bank of England (BoE).
The Bank of England (BoE) is a public entity, meaning it is accountable to citizens in the British Parliament. It is considered the oldest central bank of all, being founded on July 27, 1694. This entity is in charge of managing monetary policies on the pound sterling (£). Its board of directors consists of a governor, three deputy governors, four experts and a chief economist. Throughout a calendar year they meet approximately eight times. Its current governor is Andrew Bailey. Currently the interest rates applied by the BoE stand at 3%.
Annual and historical interest rates applied by the BoE. Source: Global-rates.com.
Bank of Japan (BoJ).
The Bank of Japan is the entity in charge of managing monetary policies on the Japanese economy and, consequently, on the Japanese yen (¥). It was founded on June 27, 1882. As the Japanese country is a state located on an island that depends largely on exports, the main objective of this organization is the preservation of the value of the Japanese currency, so that it is not even neither very weak nor very strong. This entity is made up of a governor, two deputy governors and six other members. Over the course of a calendar year they meet with the same frequency as British governors, that is, eight times.
Annual and historical interest rates applied by the BoJ. Source: Global-rates.com.
They have sometimes intervened with open market operations to try to weaken or strengthen their currency by selling the yen against the US dollar, euro or pound sterling. At the same time, they apply a different interest rate policy than usual, hovering between 0% and -0,1%. Within the foreign exchange market, it is popularly considered a reserve currency of value in times of uncertainty, since it is usually isolated from geopolitical conflicts that can influence other economies. Its current governor is Haruhiko Kuroda. Currently the interest rates applied by the BoJ are at negative -0,10%, a somewhat questionable decision given the situation we are experiencing.
Swiss National Bank (SNB).️
The Swiss National Bank (SNB) is an entity independent of the state that is responsible for managing monetary policies on the Swiss franc (CHF). It was founded on June 20, 1907 and, unlike its comrades, it has two locations; one in the city of Zurich and another in Bern. The Swiss also share a situation similar to that of the Japanese, since they depend largely on exports, which is why they are not interested in having a very strong currency.
Annual and historical interest rates applied by the SNB. Source: Global-rates.com.
Under these conditions, the Swiss country has historically maintained fairly conservative interest rate policies, remaining at negative values until very recently. This entity is made up of a three-member council that decides on interest rate policies, which, unlike their peers, determine ranges of application rates rather than objectives. The board in charge meets quarterly to supervise the correct application of these policies. Its current president is Thomas Jordan. Currently, after being frozen for almost ten years, interest rates were raised to 0,50%, something that did not sit well with the Swiss franc temporarily.
Conclusions from this investment training.
As we have seen throughout this investment training, central banks are a fundamental pillar for global economies. The correct application of monetary policies such as interest rates, asset reserve management and open market operations depends on them. In turn, we have learned about the impact that the meetings they organize have on monetary policies. As we have witnessed over the last two years, the poor application of open market operations and interest rate policies of the different entities we have mentioned have caused inflation to run amok to the levels we are currently suffering.
