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bonds for cash
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Seigniorage
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During the era of metal-based money, the monetary base
consisted of precious metals produced by the public and converted into coins by
the State. The difference between the face value of the coins versus the
cost of acquiring the metals and minting them generated a financial
benefit for the State treasury, known as seigniorage.
The Monetary Base Today
In the U.S. today the monetary base is
created by the Fed when it buys Treasury securities from the public and
simply credits the sellers' banks with reserve deposits at the
Fed. The Fed must supply reserves as needed to balance supply and
demand at its target Fed funds rate.
Cash withdrawals from banks are a drain on their reserves, which the Fed
must replenish or lose control of the Fed funds rate. A net
withdrawal of cash from banks causes a continuing demand for additional
base money from the Fed. Uner normal conditions, that is the principal
reason for the growth of Treasury securities in the Fed's portfolio.
Seigniorage in a Fiat Money System
The Fed thus acquires Treasury securities equal to the amount of base
money it creates. The interest paid by the Treasury on those securities
is the main source of income for the Fed. The Fed keeps enough to
cover its expenses, and refunds the balance to the Treasury. On average, over 90 percent of the interest paid by the
Treasury on those securities is refunded by the Fed. Thus for
all practical purposes, the Treasury securities
held by the Fed are retired.
Retiring outstanding Treasury
securities in that way eliminates a cost to the Treasury. That is the
way in which seigniorage in a fiat money system differs from the
classical view of seigniorage. The value of the seigniorage is
approximately equal to the face value of the securities held by the
Fed, which in turn is equal to the monetary base created through open
market operations. The monetary base can also be increased through
lending by the Fed, but that has no seigniorage benefit for the
Treasury.
How the Issue of Notes Affect Seigniorage
The Bureau of Engraving and Printing in the Treasury produces
all notes for the Fed. The Fed buys the notes at cost, and pays by
crediting the Treasury's account at the Fed. The Fed provides notes on
demand to banks at face value, debiting their accounts at the Fed in
payment. Banks provide notes on demand to depositors, debiting their
individual accounts in payment. Conversely depositors can return notes to their
banks and regain credits in their accounts. Likewise banks can return
notes to the Fed and regain credits in their Fed accounts.
Since the Fed buys notes at cost and sells them to banks at
face value, it would seem that seigniorage from notes accrues to the Fed. However until
the notes are sold to banks, they are not a part of the monetary base, but only engraved pieces of
paper stored in the vaults of the Fed. As the Fed sells and redeems
notes, it simply swaps liabilities on its balance sheet. The asset side
of the balance sheet remains unchanged, and the Fed gains nothing from
the “sale” of notes to banks. The more notes withdrawn, the greater the seigniorage benefit to the Treasury.
How the Issue of Coins Affects Seigniorage
The U.S. Mint, a bureau of the Treasury, produces all
coins. It sells them to the Fed at face value for credit in
its account at the Fed. The difference between the face
value of the coins and the cost of their production is seigniorage for Treasury, which accrues at the time of sale to the Fed.
Coins held by the Fed are carried on its balance sheet as assets. Those assets vanish when sold to the private sector. The
Fed sells the coins to banks at face value, who in turn sell them to
the public at face value. This peculiar distinction between
coins and notes is a hold-over from the days when the monetary base
was precious metal
Who Really Benefits from Seigniorage?
The notion that the Treasury is a beneficiary of seigniorage is an illusion. As the late economist Herb Stein observed, "The government is no one, there
is nobody here but us people." Rather it is a temporary assemblage
of citizens who
determine how the government should spend and tax. However the government must spend at least as much as it acquires from
taxes and the sale of securities. Otherwise it would drain the monetary
base and stifle the
economy.
In a modern fiat money system, the
Treasury has no need for balances in excess of its near term
obligations. If its balances increase due to seigniorage, it will have
to be returned to the private sector, either through reduced taxes or
increased spending. Thus the private sector is the ultimate beneficiary.
What about Federal Reserve notes that
are bought by foreign
interests for use overseas? If the notes never return, they represent
a large gift of seigniorage to the U.S. Again the beneficary is the U.S. private sector as a whole.
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