How do Central Banks expand their balance sheet?

[ether]

This is a basic question but I wanted to confirm and potentially get some reading material on how exactly central banks expand their balance sheet?

Question 1:
Right now as central banks expand their balance sheet member banks don't need to contribute cash to fund it and governments don't fund it via taxes, so the money comes from no where, correct?

Question 2:
When countries want to expand their central bank's balance sheet, is there anything stopping government (besides forex devaluation) from having massive deficits and forcing their central bank to buy the government debt?

Question 3:
When central banks buy corporate debt, isn't that effectively nationalization of the company? Have there been cases where central banks even buy equities of private companies?

Question 4:
What happens when central banks reduce their balance sheet, does that money just evaporate? Does it go to the treasury?

[DIY investor]

Hi, cool questions. Especially the 4th one. I wonder if it has ever happened that they have reduced their balance sheet and if yes, why.

[jacob]

1) Correct. The Federal Reserve expands its balance sheet by buying securities in the open market, typically from banks. Cash (that comes out of nothing(*)) is deposited in the account of the member bank (and becomes and asset) while the security (typically a treasury bond but potentially also other securities such as mortgage bonds or even equity) becomes an asset of the Fed. This also expands the money supply in the economy. To contract it, they do the opposite and sell bonds for cash when then vanishes back into the nothingness it came from.

(*) Similar to how the money comes out of nothing if you write yourself a check for $1M but never cash it in. It's for this reason that the Fed no longer redeems in gold.

Other ways of controlling the money supply would be in changing the reserve ratio or otherwise regulating how much cash the banks (rest of the banking system) needs to have sitting in their accounts relative to their outstanding loans. Note that regular banks can also expand the money supply (reserve banking).

2) The Fed is not a branch of the US government. It is actually owned by its member banks. Note that the Fed does not buy the treasury bonds directly from the government. The bonds are usually auctioned off directly to the public, regular banks, pension funds, and pretty much anyone, including foreign entities. The Chinese and Japanese CB own a lot of US treasuries for example. What's stopping government from issuing infinite debt is simply finite buyer demand. This has happened before (semi-regular basis). With less buyers, interest rates go up (since the bond is sold for less). The Fed mainly acts to control the money supply by buying bonds off the banks in the process described in (1) and (4).

3) No, owning bonds does not confer a controlling stake in the company, only equity does. Yes, there have been cases. For example, foreign CBs are free or even encouraged to buy US equities and have done so. These equities then sit on the balance sheet on the respective CB where they can be used like any other security. For example, the Swiss CB could own USD or US equity. If the CHF came under pressure, it could sell either USD or S&P500 futures that it owned to buy up CHF. There has also been talk of the Fed buying equity, but I don't think that has happened yet?

4) It just evaporates. If a gov bond matures in the possession of the the Fed (and the gov pays back the notional value), that money too vanishes into nothingness. And so does the expired bond for that matter. This is called unwinding. Same happens with the interest the gov pays on the bonds owned by the Fed. It's not like the gov doesn't have to pay (they money comes from taxes or from issuing ever more bonds). It's that the Fed doesn't carry a cash position (no need since it has that infinite check writing capacity) so any cash received goes away the same way it was created. Note that since all bonds eventually mature, the Feds balance sheet is always in the process of unwinding in a way.

[giskard]

For example, the Swiss CB could own USD or US equity. If the CHF came under pressure, it could sell either USD or S&P500 futures that it owned to buy up CHF. There has also been talk of the Fed buying equity, but I don't think that has happened yet?

I was doing some research and found that as of the last 13F filing the swiss national bank owns 97 billion US stock. Crazy!
https://fintel.io/i13fs/swiss-national-bank

It's all large companies you would find in SP500 mostly.

My feeling is that this really sucks for us as investors. If all of the central banks start following this behavior to get themselves out of this crisis it will continue to keep equities artificially high for a long period of time.

[jacob]

Technically this kind of asset inflation is great for investors(*) as it makes the stock market as well as the bond market go up faster than it otherwise would. It sucks more for the non-investors. First, they don't get to participate and so while they're stuck with wages which tend to decrease in real terms, investors move further and further ahead. Second, goosing the financial markets like this lead to bad capital investing which create "bad jobs"---non-essential work that would quickly vanish should the company get in financial trouble. Of course this looks good on paper because the unemployment rate is low but it's really an economy built on a house of cards. However, as long as these companies get bailed out, this can continue.

(*) Okay, it sucks for value investors.

[ether]

This is pretty cool, but all the major central banks (USA, Japan, China, EU) have roughly the same sized balance sheet currency adjusted
https://www.yardeni.com/pub/peacockfedecbassets.pdf

I'm guessing this isn't an accident and if one central bank starts expanding much faster than comparable banks then there will be some pretty serious forex devaluation to bring it back in line?

Also since foreign central banks are actually buying equity, would they really "delete" foreign denominated assets since it actually has some intrinsic value since they can't print it? For example when the central bank of Switzerland gets a dividend from its american equity do they really destroy the USD or do they keep it on their balance sheet and use that to manipulate the foreign exchange market?

[jacob]

@ether - CBs only delete or cancel their their own currency(*). All other securities including foreign currencies are considered assets. If the Swiss CB receives USD dividends from the US equity holdings, that goes into their USD reserves. If they held Swiss equity (I don't know if they can do that), then those dividends would be deleted.

(*) Well, technically, they could delete another country's currency by burning bank notes in bonfire.