How Central Banks Make a Profit

Central banks create currency out of thin air. However, this is not how they make a profit because the currency has to be sent into circulation, and it has to be destroyed when returned to the central bank.

The way central banks make a profit is that they buy something for the money they create. When this something is sold at some later time, they pocket the profit. Only the currency originally created by the central bank is destroyed. The profit is retained and passed on to the entity that owns the central bank.

As an example, we can imagine a central bank buying $100 worth of government debt, with 3% interest, and expiring in a year. This will result in $3 profit at the end of the year. The $100 used to buy the debt was created out of thin air and is returned to nothing when the government pays down the debt.

In a balanced budget, the $3 in profits is collected as taxes from the people. If the government owns the central bank, the $3 is returned to the government. If it is owned by private individuals, these individuals get to share the $3 collected in taxes.

If a central bank manages to buy $100 worth of debt for $90 dollars, the central bank makes an additional $10 dollars in profit when the debt is paid back in full. However, if the central bank spends $110 on $100 worth of debt, it makes a $10 loss. If the debt is defaulted on, the loss can be even greater.

This means that central banks can run at a loss despite their ability to print money out of thin air. While this is harmless to central banks, precisely because they can print as much currency as they please, the effect is detrimental to ordinary people because it results in a growing amount of currency that will never be returned to central banks.

The currency that isn't returned to central banks becomes worthless in the sense that it isn't any longer anchored to anything of value in central banks. It will never be returned. It's washing around in the economy with no chance of ever being drained out.

Since there's no way of distinguishing which bits of currency is anchored to anything of value, and which bits are still tied to central bank assets, the value of the currency as a whole goes down.

Sovereign

By Heritage Auctions for image, Mary Gillick for coin - Newman Numismatic Portal, Public Domain, Link