The end-of-year reviews made abundantly clear that 2022 was a year of profuse setbacks. The financial market overviews were no different. Rising prices not only caused havoc in the wallets of ordinary people.
The dramatic increase in inflation led major central banks to hike interest rates leading to a brutal year for investors. According to the Financial Times, stocks and bond markets shed more than $30 trillion (12zeros) in 2022.
Ironically, central banks are the primary victims of their own doing – monetary and exchange rate policy require investments in fixed-income securities (bonds). The prices of these bonds go down when interest rates go up, creating market losses on the balance sheet of central banks. The reason being that without a discount the bond would no longer be competitive. Investors would simply buy other securities of similar duration that will return the higher market (interest) rate. So, how did we get here and what does it mean for the future solvency and stability of central banks and, in particular, the CBCS?
After more than a decade of declining interest rates, the end of cheap money seems here. Even Japanese bonds do not see negative yields anymore since last week and ten-year Dutch treasuries yield is currently 2.59%.
Bookshelves have been filled on the causes and consequences of ultra-low interest rates. In short, there have been structural and cyclical factors at play. The structural factors behind the decline in the natural interest rates are an aging population in advanced economies, causing a savings glut, and technology in combination with globalization, driving down investments in manufacturing.
Cyclically major central banks have created $11 trillion in support of the economy by extending their
balance sheet by buying in particular government bonds with depressing yields (low interest rates). First after the global financial crisis in 2008 and 2009, then as a response to the pandemic in 2020 and 2021.
These bond-buying programs with fancy names such as the ECB’s Pandemic Emergency Purchase
Program (PEPP) are often called quantitative easing. The objective was to ease financial conditions to
support the economy as lending and borrowing was made cheaper.
There is a wide-ranging debate on the appropriateness of these policies. However, it is clear they
supported the economy in difficult times while inflation remained exceptionally low despite this
unprecedented support of demand. The sudden spike in inflation last year put an abrupt end to this.
Quantitative easing was stopped and/or placed in reverse and interest rates were hiked with the focus to bring down inflation to the target rates.
The impact of the changed monetary policies on balance sheets of central banks is considerable.
However, not all central banks are created equal. Central banks of major advanced economies have more room for maneuver. They have done the quantitative easing by buying bonds crediting the accounts of commercial banks on their balance sheet. This is sometimes called printing money.
Small central banks without international reserve currencies of their own do not have this possibility.
They hold foreign reserves to facilitate international payments and, in some cases, –
such as the CBCS – guarantee a fixed exchange rate with the US dollar. These foreign reserves are held in cash for immediate needs and in short-term bonds as a buffer and to earn income. However, one thing remains the same. The year 2022 has been painful for central bank bond portfolios. In recent months, several central banks have announced (large) losses as a result of the sudden shift in the monetary policy stance. The United States, the United Kingdom, Sweden, Belgium, Australia, Switzerland and the Netherlands all have done so, and it is expected more will follow. The Dutch Central Bank was one of the first to indicate in September last year that they projected EUR 9 billion in losses in the coming years.
For the CBCS, the fast rise in interest rates led to a large (un)realized (market) loss in the fixed-income portfolio. The total fixed-income portfolio is roughly NAf 2,3 billion. The negative investment result could, for a second year, only be offset by a positive result in book value through a transaction of selling and immediately buying back gold (keeping the physical amount constant)1
. This to avoid capital contributions by the governments in the current challenging circumstances.
One might wonder how it is possible that the low-interest rates were responsible for low profitability in the past decade and now when interest rates are rising profitability is even worse. The answer is simple. Today’s pain is tomorrow’s gain. With interest rates rising fast, the bonds in the portfolios of central banks are worth less but are being gradually sold to be reinvested in bonds at higher rates for the future (socalled rebalancing process).
Therefore, it is expected that the worst is over. The further increase in interest rates during 2023 will likely be more moderate than in 2022, limiting (un)realized losses in the existing portfolios. While the future looks brighter with the opportunity to capitalize, for the coming years, on higher yields (not seen since 2007 in the US) and eventual positive price changes over the medium term.
Having said this, it is important to remember that the primary objective of the CBCS as a central bank is not to make a profit. It is to ensure a fixed exchange rate between the guilder and the US dollar. For this, we have capital preservation and providing dollar liquidity as our primary investment policy goals, even if it hurts short-term profitability. This is the best contribution to sustainable prosperity in Curaçao and Sint Maarten.

R. Doornbosch C. Pietersz
President Manager Market Operations & Payments
January 10, 2023


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