seigniorage

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Seigniorage (pronounced /ˈseɪnjərɪdʒ/), also spelled seignorage or seigneurage, is the net revenue derived from the issuing of currency.

Overview

Seigniorage derived from specie - metal coins - arises from the difference between the face value of a coin and the cost of producing, distributing and retiring it from circulation.

Seigniorage derived from notes is more indirect, being the difference between interest earned on securities acquired in exchange for bank notes and the costs of producing and distributing those notes.^[1]

Seigniorage is an important source of revenue for some national banks.

In macroeconomics, seigniorage is regarded as a form of inflation tax, as paying for government services by issuing new currency (rather than collecting taxes paid out of the existing money stock) has the effect of creating a de facto tax that falls on those who hold the existing currency, as a result of its effective devaluation through the introduction of additional money.^[2]

Examples

Scenario A

A person has one ounce of gold, trades it for a government-issued gold certificate (providing for redemption in one ounce of gold), keeps that certificate for a year, and then redeems it in gold. That person ends up with exactly one ounce of gold again. No seigniorage occurs.

Scenario B

Instead of issuing gold certificates, a government converts gold into currency at the market rate by printing paper notes. A person redeems an ounce of gold for its value in currency, keeps that currency for a year, then trades the currency back in for an amount of gold at market value, which may yield a different amount of gold from that started with if its price has increased or decreased during that year.

If the value of gold has gone up in the interim, then the amount the redeemer receives in return for his paper notes will be less than he originally paid for them. Seignorage occurs.

If, however, the value of gold has decreased and the redeemer gains more than he paid in, it has not.

Seignorage, therefore, is the positive return on issuing notes and coins, or "carry" on money in circulation.

The opposite, "cost of carry", is not regarded as a form of seignorage.

Ordinary seigniorage

Ordinarily seigniorage is only an interest-free loan (for instance of gold) to the issuer of the coin or paper money. When the currency is worn out, the issuer buys it back at face value, thereby balancing exactly the revenue received when it was put into circulation, without any additional amount for the interest value of what the issuer received. Currently, under the rules governing monetary operations of major central banks (including the central bank of the USA), seigniorage on bank notes is simply defined as the interest payments received by central banks on the total amount of currency issued. However, if the currency is collected, or is otherwise taken permanently out of circulation, the back end of the deal never occurs (that is, the currency is never returned to the central bank). Thus the issuer of the currency keeps the whole seigniorage profit, by not having to buy worn out issued currency back at face value.

Seigniorage as a tax

Seigniorage can be seen as a form of tax levied on the holders of a currency and as such a redistribution of real resources to the issuer. The expansion of the money supply causes inflation in the long run. This means that the real wealth of people who hold cash or deposits decreases and the wealth of the issuer of the money increases. This is a redistribution of wealth from the people to the issuers of newly-created money (the central bank) very similar to a tax.

This is one reason offered in support of the free banking, a gold standard, or at a minimum the reduction of political control over central banks. The latter could then take as their primary objective ensuring a stable value of currency by controlling monetary expansion and thus limiting inflation. Independence from government is required to reach this aim - indeed, it is well known in economic literature that governments face a conflict of interest in this regard. In fact, "hard money" advocates argue that central banks have utterly failed to obtain the objective of a stable currency. Under the gold standard, for example, the price level in both England and the US remained relatively stable over literally hundreds of years, though with some protracted periods of deflation^{[citation needed]}. Since the US Federal Reserve was formed in 1913, however, the US dollar has fallen to barely a twentieth of its former value through the consistently inflationary policies of the bank. Economists counter that deflation is hard to control once it sets in and its effects are much more damaging than modest, consistent inflation.

Ultimately, banks or governments relying heavily on seigniorage and fractional reserve sources of revenue will find it counterproductive. Rational expectations of inflation take into account a bank's seigniorage strategy, leading to economy-damaging hyperinflation. Instead of accruing seigniorage from fiat money and credit most governments opt to raise revenue primarily through taxation and other means.

Seigniorage today

The "50 State" series of quarters (25-cent coins) was launched in the U.S. in 1999. The U.S. government planned on a large number of people collecting each new quarter as it rolled out of the U.S. Mint, thus taking the pieces out of circulation^{[citation needed]}. Approximately 147 million people are collecting the coins.^[3] Each set of 50 quarters is worth $12.50. Since it costs the Mint about five cents for each 25-cent piece it produces, the government made a profit whenever someone "bought" a coin and chose not to spend it.^[4] The U.S. Treasury estimates that it has earned about US$4.6 billion in seigniorage from the quarters so far.^[5]

In some cases, national mints report the amount of seigniorage provided to their respective governments; for example, the Royal Canadian Mint reported that in 2006 it generated $C93 million in seigniorage for the Government of Canada.^[6] The US government, the largest beneficiary of seignorage, earned approximately $25 billion annually as of 2000.^[7]

According to some reports, currently over half the revenue of the government of Robert Mugabe in Zimbabwe is in seigniorage.^[8] Zimbabwe has experienced hyperinflation (see Hyperinflation in Zimbabwe), with the annualized rate at about 231,000,000% in July 2008 (prices doubling every 17.3 days).^[9]

Overseas Circulation

A very profitable type of seignorage is from the international circulation of banknotes. While the cost of printing banknotes is minimal, the foreign entity must provide goods and services at the face value of the note to obtain it. The banknote is retained because the entity values it as a store of value because of mistrust of the local currency. He also values it for the privacy and the ease with which he can use it in transactions. Many of these transactions may be illegal with respect to local or international law.

American currency has been circulating around the world for most of the 20th century. Certainly in World War II, the amount of currency in circulation was increased several fold. However, the modern era of huge printings of the United States one hundred-dollar bill started with the fall of the Soviet Union in 1991. Production was quadrupled with the first ever trillion dollar printing of this bill. As of the end of 2008, roughly twenty $100 banknotes and twenty $20 banknotes per person were in circulation, but the overwhelming majority of $100 bills circulate overseas.

The American $100 bill has some competition, primarily from the €500 note. The larger value of the banknote makes it easier to transport larger amounts of money. As an example if you are trying to carry $1 million in currency on board an airplane, and it is in $100 bills, the weight of the money is 22 pounds. It is difficult to carry this much weight without a briefcase with some physical security. Since it is against IRS regulations to carry more than $10,000 without reporting it, you would be very unlikely to be able to get it through security unnoticed. The same amount in €500 notes would weigh less than three pounds, and you could probably disperse it in your clothing and various places in your luggage without attracting attention or alerting a security device.

The Swiss 1000 franc note, is probably the only other banknote that is in circulation outside of its home country. It is worth slightly less than US$1000. However, to the non Swiss it doesn't provide a significant advantage over the €500 note as there are 20 times as many of the €500 note circulating and they are more widely recognized. As a reserve currency it is roughly 0.1% of the currency composition of official foreign exchange reserves.

Governments differ radically in their issuance of large banknotes. As of August 2009, there were roughly 26.5 million of the 1000 Swiss franc banknotes in circulation, while Switzerland has a population of only 7.5 million. That is over 3 banknotes per person. In comparison the UK has 174 million of the £50 banknotes while UK has a population of 61 million. That is less than 3 banknotes per person. But the 1000 franc banknote is worth roughly £600. The British government has traditionally been wary of large banknotes since the counterfeiting operation Operation Bernhard, which caused the Bank of England to withdraw all notes larger than £5 from circulation, and not reintroduce other denominations until the early 1960s (£10), 1970 (£20) and 1980 (£50).

There is a banknote for 500 Latvian lats which is currently the most valuable note in the world, as it is worth more than $1000, but it is unlikely to be accepted outside of Latvia. Other currencies in Europe, like the British pound, and the Scandinavian currencies do not issue large value banknotes. Iceland in particular has never needed much currency since electronic transactions are commonplace, and their population is small with over 60% of the population living in one metropolitan area. Their largest banknote is worth less than €28.

South Korea is an example of a country with a very high Human Development Index that fears counterfeiting so much that they don't take advantage of large banknotes. They have a larger Purchasing power parity per capita than Latvia, but until recently their largest banknote was only worth about US$8 which was a severe impediment to routine business. On June 23, 2009 they issued a new banknote worth five times as much.

The American treasury considered re-issuing a US$500 banknote when the Euro banknotes began circulating. There was concern that the high value banknotes would provide competition. However, recognition that these larger banknotes would provide huge advantage to worldwide criminal operations and dictatorships, the decision was made not to pursue this option.

Canada briefly issued a $1000 Canadian dollar bill in 1992, but the Royal Canadian Mounted Police was able to successfully argue against the continued printing of this bill in 2000. It is still legal tender but no more are being printed, and it will diminish as older bills are destroyed. It was not widely circulated outside of Canada.

See also

• Central bank
• Digital gold currency
• Fractional reserve banking
• Full reserve banking
• Money
• Monetarism
• Demurrage (currency)

External links

• Extensive discussion
• Sovereignty & Seignorage
• Information about Seigniorage
• "The temptation of dollar seigniorage", By Kosuke Takahashi of Asia Times Online, January 23, 2009.

References