During the era of metal-based money,
the monetary base consisted of precious metal coins. The difference between the
face value of the coins and the cost of acquiring the metal and minting them
generated a financial benefit for the State treasury, known as seigniorage. In a modern fiat money system the meaning of seigniorage is quite
Seigniorage in a Fiat
In the U.S. today the monetary base
is created by the Fed when it buys Treasury securities from the public and
credits a seller’s bank with a reserve deposit at the Fed. Interest paid
on Treasury securities acquired by the Fed is the main source of income for the Fed.
The Fed keeps enough to cover its expenses, and refunds the balance to the
average, over ninety percent of
the interest received by the Fed is refunded to the Treasury. The
refunded amount is a source of spending power for the Treasury which is
independent of tax revenues. Thus it is the
equivalent of seigniorage for the Treasury. The value of the
seigniorage automatically increases as the Fed monetizes Treasury
securities to meet the
private sector demand for additional cash.
How the Issue of Notes
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.
Until the Fed issues the notes to
banks, they are not a part of the monetary base, but only engraved pieces of
paper stored in the vaults of the Fed. 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 when the Fed issues or redeems notes with
banks, it simply swaps liabilities on its balance sheet. The asset side of
the balance sheet remains unchanged.
Thus the Fed gains nothing from the “sale” of the notes.
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
Who Really Benefits
As the late economist Herb Stein
observed, "The government is no one; there is nobody here but us
other words, government should be viewed as a public trust, rather than
the people who work for it. All citizens, including government
officials, are tax-payers and consumers of government services. It
follows therefore that the seigniorage benefits accrue to the
people as a whole and not the government itself.
What about Federal Reserve notes
that are bought by foreign interests for use overseas? The foreign currencies
acquired from the purchase of those notes represent a claim on foreign goods
and services. If the notes never return, they are a gift of
seigniorage to people of the U.S.