This article does not constitute investment advice, an activity reserved for professionals recognised by the regulatory authorities.

In times of uncertainty, people tend to reduce their consumption and increase their savings. But not just any old way, because while French savers are normally cautious by nature, they become particularly wary when the economic outlook darkens. And that’s precisely when so-called “risk-free” or “guaranteed” investments see their inflows literally explode. Except that, from savings books (Livret A) to life insurance, deposit accounts, savings plans and even cash, none of these solutions is really risk-free. Worse still, some of these tools will even cause you to lose money almost every time.

Risk in proportion to profitability

No matter how many times it’s been said, many people still haven’t realised that risk follows profitability, and that you can’t have the latter without the former. In other words, the more profitable an investment is, the riskier it is; anyone trying to sell an investment that is both highly profitable and risk-free is either a fool or a fraud. And as there are very few fools who go into the business of selling financial products… So be extremely wary of those who might offer you the deal “that financial professionals would like to keep to themselves” or the investment “that makes bankers tremble”.

Be that as it may, it is perfectly acceptable to assume a minimum of risk in return for a certain level of profitability. This is the case, for example, with SCPIs in France, which can offer a return several times higher than the rate of growth (or inflation), provided you accept the possibility of losing a little money if the markets turn unfavourably.

You can also choose to focus on the security of your capital, even if it means gaining little or nothing, the primary objective being to lose nothing. The ultimate wealth strategy is to keep all your capital in one or more demand deposit accounts, also known simply as current accounts (although they are not quite the same thing). No return, of course, but the sums deposited are theoretically recoverable in full.

At the other end of the spectrum, there are purely speculative investments that are more akin to casinos or lotteries. Here, the only important thing is the possibility of maximum return, with no regard for risk. Trading on the stock market, investing in companies (also known as private equity) and, especially in recent years, crypto-assets (Bitcoin, NFT, etc.) are all solutions that can generate a lot of money… but can also lead to major losses, or even outright ruin for the least cautious (or greediest) savers.

Between the two, there are products that are well known to individuals, some of which have even become the favourite investments of the French. These are, of course, passbook savings accounts (Livret A) and life insurance, two savings solutions touted as being both risk-free and yielding high returns. Together with tax-free savings plans and passbooks (the Sustainable and Solidarity Development Booklet (LDDS), the People’s Savings Booklet (LEP), the Young Booklet, the Housing Savings Plan (PEL) and the CEL (Home Savings Account, etc.), these are the perfect products, combining capital security with a (small) return. A fair balance, so to speak.

The reality is more nuanced, and even these investments that we imagine being risk-free often expose us to significant financial losses.

No investment is truly risk-free

The first distinction that needs to be made concerns the assessment of risk itself. The notion of risk does not necessarily have the same definition for everyone. While some savers fear above all the loss of purchasing power of their capital, others will see the risk more in the immobilisation of their assets or in the reliability of their financial intermediary. Generally speaking, and more particularly when it comes to finance, there is ALWAYS a risk. The safest products are simply those designed to minimise the risk of capital loss.

Among the risks that persist despite all the precautions, we can refer to the liquidity risk. It is an inherent part of certain savings products whose operation involves blocking capital for a relatively long period, with no possibility of withdrawal (retirement savings, or PER, for example). There is also the counterparty risk, with the possibility that the financial operator, bank or insurance company, might go bankrupt or become totally insolvent. Finally, we must not forget inflation, which has a direct impact on all investments. This includes so-called risk-free investments, which not only affect their potential profitability, but sometimes even directly reduce the value of the capital invested.

This is particularly true of all investments whose interest rate is lower than the rate of inflation. More specifically, savings accounts (Livret A) and life insurance, whose returns in recent years have been increasingly negligible in the face of price rises that are now reaching record levels. And needless to say, money merely deposited in a current account simply sees its value fall from the very beginning, in proportion to the normal rise in the cost of living. So, even with an interest rate now set at 1% per annum, the savings account (Livret A) exposes savers to a net loss of 4% of the value of their capital because of inflation, which is currently running at around 5% in France. The same goes for euro-based life insurance, which is touted as being safer than its smaller sister in unit-linked products (in this case, ‘shares’), but which on average offers a return barely higher than that of the savings account. And that’s without taking into account the social security contributions that apply in the event of withdrawal.

There is another, more subtle risk to life insurance, linked to management fees. Insurers have got into the habit of charging a percentage of the actual return on their products. However, when the return is no longer there, the management fees naturally fall to zero or almost zero. This is an unsustainable situation, and many companies have decided to counter it by changing the way their management fees are calculated, so that they are now based on the capital invested (and no longer on the capital gain achieved). As a result, even in the event of a zero or even negative return, their customers’ savings are gradually being eaten up by management fees, with no regard for the notion of “guaranteed capital”.

It should be noted that this phenomenon also occurs on a much simpler type of account, the current account, which is most often associated with a package offered by the bank in return for the annual payment of account management fees.

What about so-called safe havens?

You might say that the solution is to convert your capital into tangible assets whose value rises with inflation and which are unlikely to disappear over time. This is particularly true of real estate and precious metals. While these assets offer no significant return (or even no return in the case of gold, for example), they do offer the possibility of preserving the value of your capital and increasing its purchasing power over time, as inflation erodes the value of monetary currency. This is why they are known as “safe havens”: currencies may be devalued, stock markets may collapse, and the entire economy may disappear in a major crisis. However, a building will always remain a place of refuge and a gold or silver coin will always retain its universally recognised exchange value.

In a more traditional situation, i.e. with an economy that is progressing year on year without excessive speed but without any real major crisis either (despite the apocalypse theorists), this type of asset is very important in a balanced portfolio. It offers great resilience to temporary turbulence and provides at least a partial guarantee of the integrity of your capital.

However, here again, we cannot talk about 100% ‘guaranteed capital’ or even risk-free investments, because safe havens are also subject to certain unavoidable, although limited, hazards. For example, while the yield on a rental property may be adversely affected by a prolonged period of vacancy or even by unpaid rent, the value of the property itself may also fall as a result, of damage to the property or a downturn in the market (property crash) or, for example downgrading of the geographical area in which the property is located (impoverishment of the neighbourhood or industrialisation of the surrounding area) or a change in legislation on living standards (energy performance, anti-pollution standards, etc.). In such cases, the value of the property depreciates and the capital invested in it is no longer guaranteed.

As for gold and precious metals in general, everything will depend on how they are kept, bearing in mind that such assets are coveted and can therefore be stolen, resulting in a total loss of capital. But it can also happen that, in the case of coins in particular, and more especially those that have been acquired with a premium linked to their condition (new, corner jewel, splendid, etc.), poor storage conditions lead to a deterioration in their general appearance (scratches, wear, impact marks), drastically reducing their market value and at the same time causing a more or less significant loss of the corresponding capital.

As a result, even if some assets are more protective than others, the total absence of risk can never be guaranteed. That said, a good investment strategy consists first and foremost of diversifying your savings, if possible by combining secure investments (Livret A, LDD, safe havens) to protect part of your capital, and riskier products (with potentially higher returns) to boost your assets. It’s up to each investor to find the level of risk they are prepared to accept in relation to the expected gains.

What is a central bank like the ECB or the FED?

In practical terms, a central bank is a body entrusted by a State, or a group of States, with the management of its currency. This implies that it not only guarantees the legitimacy of the currency but also controls its issuance, distribution and stability, both within and outside the borders of the State(s) concerned. A central bank is therefore an essential element for the proper functioning of institutions, but beyond this definition, which is very similar to those found on most central bank websites, not much has been said. Let’s try to answer some more specific questions to better understand the nature and objectives of these special institutions.

What is the role of a central bank?

This may seem like an obvious question, but it is not so easy to answer. As mentioned above, a central bank is responsible for the monetary policy of one or more states. However, its powers and the means at their disposal to accomplish its mission vary from one bank to another. It mainly depends on its history, but also on its links with the state or states whose currency it controls. For example, apart from its monetary responsibility, the mandate of the European Central Bank (ECB) gives it the priority of controlling inflation and above all ensuring price stability throughout the Eurozone, by using interest rate leverage in order to act on the supply and demand of financing. The US Federal Reserve (Fed), for its part, also has the task of promoting full employment by supporting growth. This is why the announcement of the monthly US employment figures is so important for the US financial markets, to the point of directly influencing the level of the main Wall Street stock exchange indices. A faltering jobs market is seen as a reflection of insufficient Fed action, and therefore of weak monetary policy.

Do the ECB or the FED make money?

In reality, no, central banks do not create money as such. Unlike in the past, when the central financial institution (the “Treasury”) issued currency mainly in the form of coins, and later banknotes. This was done according to the wealth available in the state’s treasuries, however the current monetary system is based on the principle of monetisation of claims. In other words, it is the commercial banks that create money each time they grant a loan to a customer. Since this money, known as demand deposit or checkbook money, only exists in the form of “credit lines”, it is exactly the same as the money we have in our savings books, current accounts or financial investments. It is the money that we use every day when we pay for our purchases by bank card, when we pay our bills by transfer or direct debit and that we receive in the form of salaries, allowances, health reimbursements, etc.

However, the central bank also creates money, known as central bank money, which is used for trade between commercial and national banks, all of which have accounts with the central bank. But this money does not participate in the exchanges of the real economy, it only serves to regulate the system and as a clearing unit between banks.

Finally, the central bank generally retains the power to issue fiat money, i.e. the production of coins and notes. For many people, this is still the most concrete and most important representation of monetary sovereignty. In reality, this physical money, or hard cash, represents only 5 to 15% of the total money supply in circulation (which varies according to the country). This proportion is tending to fall year by year, in the face of the general shift towards electronic payments. It should be noted, however, that in the case of the Eurozone, most of the banknotes in circulation and all the coins are manufactured by the national central banks (in France, the Banque de France), under the control of the ECB, which remains the sole decision-maker on the volumes issued in order to avoid any form of monetary inflation. The decision to leave the production of coins and banknotes in the hands of the State also reflects a strategy of social appeasement. Even though their economic value is low compared to all monetary assets in circulation, their symbolic, not to say sentimental, value remains very strong in the collective imagination.

What is ‘government’s bank’?

Since we know that it does not create money, why is it that a central bank is sometimes referred to as “government’s bank”?

One of the tasks of a central bank is to finance the economic policy of states. Therefore, it has happened that some countries spend a bit more than they can afford, especially in terms of government operations, military spending or even social policies that are a bit populist. The central banks of these countries were therefore called upon to finance these public deficits, in particular by granting an advance to the public treasury via a credit granted to the State. It is as if they were lending them money in the form of bank notes, which is what happened in 1923 in Germany under the Weimar Republic.

The trouble is that this generosity is often accompanied by a feeling of fiscal immunity on the part of the indebted governments, who feel that they have a free rein to continue their lenient policies. As the same cause produces the same effect, the state finds itself in need of a loan when it comes to repaying its debt. And the central bank may be forced to issue a new one to pay off the previous and cover future expenses. It is easy to see how this kind of situation can quickly get out of hand, leading to uncontrollable inflation and currency depreciation.

What is Quantitative Easing or QE?

The ECB has a somewhat different instrument, but the effects are relatively the same from the point of view of the Member States, which is why this practice is prohibited in the Eurozone. And that is why it is often confused with the famous “money printing”.

This is the quantitative easing (QE) programme, which consists of the central bank buying bonds issued by the State to finance its public debt. It can do this either directly when they are issued (this is the case of the Fed in the United States or the Bank of England, for example), or indirectly by turning to institutional investors (banks, insurance companies, pension funds, etc.) who have acquired them and who sell them on a secondary market.

This is what the ECB does and, in the end, the euro zone States thus benefit from a strong guarantee that their securities will be bought. And so, they will be able to finance their economic policy, without inflating the money supply in circulation since the money remains in the financial market circuit.

How do central banks control money?

In simple terms, central banks act on the quantity of money in circulation by increasing or reducing the financial pressure on commercial banks.

As we have seen, money is essentially written down, not to say virtual. It is created by banks according to the demand for financing from economic agents. As the number of loans increases, so does the quantity of money. But this money cannot be created without limit by the commercial banks either, simply because they obtain it from the central bank in return for an interest rate that they have to pay. And it is precisely this interest rate that constitutes the main instrument by which a central bank can regulate the quantity of money in circulation.

If the central bank increases the rate at which commercial banks can borrow money from it, then the latter will be obliged to transfer this increase to the loans they grant to individuals and companies. Doing so and also applying limits to the debt-to-income ratio of economic agents, fewer borrowers will qualify for loans. The number of loans accepted, and the sums lent, will therefore fall, thereby reducing the quantity of money created on this occasion.

Conversely, a fall in the central bank’s key rate, and therefore a fall in the borrowing cost of money, will enable commercial banks to reduce the lending rate and therefore attract more borrowers, thereby increasing the quantity of money created.

Other more subtle mechanisms, as well as other rates such as the deposit rate, also come into play in the regulation of the money supply, but overall, the principle remains the same: to make banks adapt their own contribution to the financing of the economy in order to remain profitable.

Have central banks deprived states of their economic sovereignty?

On reading the above, one can rightly wonder about the economic sovereignty of states, and whether, in the end, central banks have taken it over or not. This question has been a source of concern for decades, and its importance has been reinforced in France with the birth of European monetary union and the creation of the European Central Bank. Indeed, the latter has not only recovered the sovereign power to “mint money”, but has also come to be placed above the State in its capacity as a community institution that no longer depends on any government.

It is true that European monetary construction has largely contributed to depriving the Member States of an important instrument of adjustment. Since any national monetary policy is now impossible, and budgetary policy is strictly controlled by the European Stability Pact, public deficits are now restricted. For example, currency devaluation can no longer be used to remain internationally competitive.

But even more than that, the ECB is taking advantage of an exceptional situation. On one hand, 19 States which, because of their inability to define a common policy, are unable to impose anything on it. On the other hand, Community authorities with too few powers to have the means to influence its decisions.

Are the ECB and the FED independent?

In the case of the ECB, it is this very principle of independence that is now being criticised. While a strong single currency did indeed require a fully autonomous regulatory body with a multinational mandate, it was soon realised that the particularities of the economies and policies of each Member State did not always fit in with the requirements set at the European level.

On the other hand, many now believe that the euro is nothing more than a revisited Deutschemark. Its strength penalises rather than benefitting most national economies that are unable to compete with the German economy. Moreover, the headquarters of the European Central Bank is in Frankfurt, Germany, and it is probably not by chance either.

Conversely, other countries such as the United States and Japan still have a certain amount of power over their central banks. Notably through the appointment of the members of the board of governors, including the president and vice-president, as well as the senior officials whose salaries they set. The independence of these central banks is therefore more or less controlled by their respective governments. Thus, their actions are more or less directly related to political choices made at the top of the state. According to many experts, this explains the great ‘flexibility’ of the American economy, as well as the low growth capacity of the euro zone, whose restrictive monetary policy is mainly modelled on the German model. A model which, as we have recently seen, could not withstand a major systemic crisis, precisely because of its excessive austerity in terms of public financing.