Banknote Short Follow Up

I have again been ambushed by distractions — Christmas shopping and consulting (to pay for the Christmas shopping). I just have a few short addenda to my earlier post on how banknotes are central bank liabilities.

Banknotes are Matured Bearer Bonds

Accounting is supposed to reflect economic reality, not what statutes might say. Otherwise, statutes could just define central bank balance sheet entries to be whatever sounds good. One hallmark of economic reality is to look through the superficial features of an instrument, and see what they are economically equivalent to.

The Bank of Canada could add the text “The Bank of Canada will pay registered agents $20 for this note after <date in the past>” and it would have no effective change on how the $20 bill is used. They are passed around until they end up at a private bank (or any other company that deals with banknote distribution) which then ships them back to the Bank of Canada to get a $20 payment. (These are the “registered agents” in the text.)

The text makes the $20 bill a bearer bond, albeit bearers have to go to an agent to effect redemption. A bearer bond is certainly a liability, and a matured one is even more liability-er.

Coin

Coins are an interesting case that I have not had time to examine. I just looked at the Bank of Canada, and the balance sheet entries only refer to banknotes. (I think this was true for the Federal Reserve, as well.)

However, it is not clear to me that the Bank of Canada deals with coins. The Canadian Mint produces coins, and it is not clear to me that they are ever returned to the Mint. A very cursory examination of the Mint’s financial statements does note a “face value liability” entry, but that entry appears to refer to a (discontinued?) programme of issuance of silver coins with a fixed face value. (The financial statements note that they could not come up with a reliable measure of this liability, which might result from the possibility that the market value of the silver coins greatly exceeds the face value.)

If coins are minted and there is no mechanism to return them, then they should be dropped from the balance sheet. However, this is not true for banknotes.

I think some version of the previous article will make its way into my banking book, and I will dig into where coins fit in as part of the editing process.

Federal Reserve H.4

The Federal Reserve H.4 report does an end run around the linguistic debate by taking a novel approach to presenting its balance sheet. The title of the report is “ Federal Reserve Balance Sheet: Factors Affecting Reserve Balances” and the line items are presented by their arithmetic effect on reserve balances.

The balance sheet equation is:

(Left Side of the Balance sheet a/k/a Assets) = (reserve balances) + (Everything else on the right side of the balance sheet).

We can then use basic arithmetic to see that assets add to reserve balances, while everything else on the right hand side subtracts from them.

This presentation side-steps whether reserve balances are “liabilities” or “equity” on the balance sheet, but there is no good reason to question the accountants on their decision.