(Bloomberg Opinion) -- Central banks around the world are doing everything they can to soften the financial and economic blow of lockdowns aimed at containing the coronavirus. But as owners of more than $13 trillion in foreign exchange reserves, they’re also major investors whose actions can either support or undermine their policy efforts.
To achieve the right outcome, they’ll need to make sure their investment actions calm rather than inflame markets further.
Following in the footsteps of the U.S. Federal Reserve, many central banks have taken extraordinary measures to ensure that financial institutions, companies and governments can obtain the funding they need to meet obligations, keep operating and fight the pandemic. They have pledged to buy an ever-widening array of securities, and they have established swap lines to provide borrowers outside the U.S. with much-needed dollars and avert unnecessary panic. All these actions are needed. All are to be lauded.
Unfortunately, past experience suggests central banks’ foreign exchange reserves aren’t always managed in accordance with such desirable goals. These reserves include not only cash and safe government bonds, but also several trillion dollars’ worth of riskier assets, such as high-grade corporate debt, mortgage-backed securities, equities, peripheral European sovereign debt and gold. Like other investors, central bank reserve managers hate losses and volatility, and hence have been known to head for the exits at the same time as everyone else. This can exacerbate the very market distress that their policy-making colleagues are trying to calm.
Reserve managers have added fuel to the fire on several occasions, including the European credit crisis of 2011 to 2012, the mortgage bust of 2008 and 2009, and the remarkable case of gold at the turn of the millennium. In each instance, their selling contributed to disorderly markets and imperiled global financial stability – for example, complicating efforts to provide Spain, Italy and Portugal with access to cheap credit, and to maintain funding for U.S. mortgage guarantors Fannie Mae and Freddie Mac. (In the latter case, the Fed came to the rescue and made a tidy profit on the guarantors’ short-term debt.)
Of course, reserve managers must act in the interests of their respective economies. We’re not suggesting that they be braver and assume losses or refrain from selling if that’s what’s needed. Their objectives are rightly safety, liquidity and return, in that order. But succumbing to herd mentality achieves none of the three. And actions that seem individually rational can be collectively disastrous. Assuming they have no immediate need for cash and hence can afford to take a longer-term perspective, now is not the time for central banks to retreat from riskier assets. Time horizons matter. By any measure, the future, long-run return prospects of many asset classes now exceed those of the largest advanced nations’ government bonds.
On occasion, central bankers have demonstrated a willingness to collaborate in furthering their collective best interest. On September 26, 1999, fifteen European central banks signed the first Central Bank Gold Agreement, announcing they would coordinate their sales to prevent market dislocation. The agreement was so successful that they renewed it every five years with a growing number of signatories. Central banks working together achieved something they could never have done on their own: greater market certainty, improved stability in a shared asset class and a more secure global financial system.
And they can do the same today. Reserve managers holding equities, corporate credit, mortgage-backed securities and peripheral European sovereign debt can individually or collectively state that they own these assets for the long term and will seek appropriate buying opportunities, rather than heading for the exits. And they can restate their commitments to being responsible investors in global capital markets, now and for the long term.
In other words, central banks need to show the same spirit of global coordination when acting as investors as they do as policy makers. Doing so will enhance their efforts to help the global economy weather this terrible episode.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Isabelle Mateos y Lago co-runs BlackRock’s Official Institutions Group and is a managing director at BlackRock.
Terrence Keeley co-runs BlackRock’s Official Institutions Group and is a managing director at BlackRock.
©2020 Bloomberg L.P.