|
|
bonds for cash
|
Seigniorage
|
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, known as seigniorage.
The Monetary Base Today
In the U.S. today the monetary base consists of cash (notes and coins) and bank-owned deposits at the
Fed. Notes and Fed deposits are carried as liabilities on the Fed’s balance
sheet. Coins are not, as will be explained. All three
are fiat money, meaning they have little or no intrinsic value and are
money by government fiat. To back that up, the government
requires that all payments to it be made in its own fiat money.
The amount of cash issued is a
function of demand and is not at
the discretion of the Fed. Since cash earns no interest, the
public
normally holds only what it needs for current use. Likewise Fed
deposits earn no interest so banks hold as little as needed.
Banks need reserves to back the demand deposits they create
through lending. Whether issued as Fed deposits or cash, the
creation of the monetary base by the Fed generates significant
seigniorage
for the State.
The Production and Distribution
of Notes and Coins
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. 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.
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 coins.
Banks “buy” notes and coins as needed to meet the
demand for them by their depositors. Since a bank's vault cash is part of its
reserves, the net withdrawal of cash reduces aggregate banking system
reserves. In order to maintain control of the Fed funds rate, the Fed
must replenish those reserves. It does so by buying Treasury
securities in the open market, which increases aggregate bank deposits at the Fed. In effect, the public acquires cash by
selling Treasury securities to the Fed. Conversely it disposes of excess
cash by buying Treasury securities from the Fed.
Seigniorage from Notes and Fed Deposits
Since the Fed buys notes at cost and sells them to banks at
face value, it would seem that the seigniorage from notes accrues to the Fed
rather than the Treasury. 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, so the Fed gains nothing from
the “sale” of notes to banks.
Interest
earned on the Fed's portfolio of Treasury securities is income for the Fed. However the
Fed retains only what it needs for operating expenses and refunds the remainder
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, those Treasury securities
are
retired.
The
present value of the refunded interest payments about equals the face
value of the Treasury
securities in the Fed's portfolio. Seigniorage thus accrues to the Treasury and is about equal to
the monetary base, less the cost
of producing and servicing the notes and coins.
Who Really Benefits from Seigniorage?
In a democratic nation with a modern fiat money system,
the view that seigniorage benefits the government is misleading.
As the economist Herb Stein observed, "The government is no one, there
is nobody here but us people." Rather it is simply an assemblage of citizens who, while in office,
determine how the government should spend in support of the economy. Indeed the government must spend at least as much as it acquires from
taxes and bond
sales. Otherwise it would drain the monetary base and stifle the
economy. In effect, seigniorage is a measure of the net financial wealth of the private sector. Whether that wealth is distributed equitably depends upon the actions of its elected officials.
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. Whether the notes
are
purchased in exchange for a foreign currency or acquired by selling
goods and services, the U.S. private sector as a whole is the beneficiary.
Next
Article Home
|