Who Benefits from Seigniorage? 10 comments
William Hummel
About this author:
-
Font Size:
-
Print
- TweetThis
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. Under 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.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 10 comments:
1. "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." This quote is similar to the concept that a small amount of inflation is supportive of economic growth. A leading monetarist, Milton Friedman, proposed that our fiat currency should be expanded by 2-3% a year by this reasoning.
2. "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." However, if the dollar is replaced by some other currency as the world's dominant means of exchange, these ex-patriate dollars will come home because they will no longer have their former usefulness overseas. This would be a new surge (or at least a pulse) in our domestic money supply and add to inflationary pressures.
This is a useful article for future reference. I will come back to it.
For the U.S. dollar to maintain its overseas value, there must be a perception that the U.S. has value in its institutions, especially in its private institutions.
Most ordinary people who buy things in other places have some healthy skepticism about government production of goods and services.
Joint ventures in China have plastered U.S. brand logos nearly everywhere in the cities where manufacturing plants are located. It is very difficult to put value on that brand identification in current times, but there is value there, and there is value in relationships of trust and shared interest among persons.
In Brazil and Europe, the major U.S. car companies modified their products to meet local demands. There is great value in these plants, but the value is for that local market, and it depends on the priorities of consumers there. If demand for private vehicles does not hold up in those markets, the value of the property may decline if it sits idle, possibly affecting the property around it.
Little mentioned in the press has been the possibility of selling foreign assets. The effect would be to repatriate some dollars in an orderly way. It is not necessary to own real estate if what you really have to sell is design and engineering for a specific niche not covered by local companies.
GM refused to sell a plant in Germany that it has had since early in the twentieth century. The proposed German re-use of the plant would have been for renewable energy.
What worries me in the U.S. right now, concerning creating and retaining value in our private institutions, is the difficulty of sheltering promising new processes from lumbering older organizations' attempts to wheeze down huge amounts of cash for obsolete processes.
Perhaps in some of the states, there will be mini-climates where poor federal behaviors have less influence. One thing this country has going for it is that it is so spread out and so difficult to completely control from a central place.
With no change in the target Fed funds rate, bank lending rates will not remain essentially unchanged. Consequently the public demand for bank loans will remain unchanged leaving the money supply unchanged to first order. Thus there should be no inflationary pressure caused by a large inflow of repatriated cash.
On Dec 28 11:49 AM John Lounsbury wrote:
> 2. "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 beneficiary is the U.S. private sector as a whole." However, if the dollar is replaced by some other currency as the world's dominant means of exchange, these ex-patriate dollars will come home because they will no longer have their former usefulness overseas. This would be a new surge (or at least a pulse) in our domestic money supply and add to inflationary pressures.
The repatriated dollars will return to the vaults of the Fed as banks acquire them, and trade them to the Fed for reserve deposits they can sell in the Fed funds market. The Fed will have to soak up the excess reserves to maintain control of the Fed funds rate, which it does by selling its own Treasuries to the public.
With no change in the target Fed funds rate, bank lending rates will remain essentially unchanged. Consequently the public demand for bank loans will remain unchanged leaving the money supply unchanged to first order. Thus there should be no inflationary pressure caused by a large inflow of repatriated cash.
Member banks must subscribe to stock in their regional Federal Reserve Bank in an amount equal to 3 percent of their capital and surplus. They receive a 6 percent annual dividend on their stock. However the stock does not carry with it the control and financial interest that is normal for the common stock of a for-profit organization. It offers no opportunity for capital gain and may not be sold or pledged as collateral for loans. The stock is merely a legal obligation that goes along with membership. For more detail visit wfhummel.net/fedovervi....
On Dec 28 01:51 PM pbf123 wrote:
> Who benefits when the FED provides notes on demand to the banks (at
> no interest, actually paying interest to the banks currently from
> my understanding) who in turn DO NOT provide notes on demand to individuals/depositors...
> Is this a breakdown in how the FED was meant to work? Also, where
> does the money for the 6% dividend paid to FED Reserve Shareholders
> (Banks) get generated from, and how does it affect the balance sheet?
On Dec 28 06:06 PM William Hummel wrote:
> Banks are required to provide notes on demand to depositors. The
> banks acquire notes from the Fed in exchange for debits to their
> Fed deposits. The Fed, the banks, and the depositors all break even,
> simply swapping one form of money for another.
>
> Member banks must subscribe to stock in their regional Federal Reserve
> Bank in an amount equal to 3 percent of their capital and surplus.
> They receive a 6 percent annual dividend on their stock. However
> the stock does not carry with it the control and financial interest
> that is normal for the common stock of a for-profit organization.
> It offers no opportunity for capital gain and may not be sold or
> pledged as collateral for loans. The stock is merely a legal obligation
> that goes along with membership. For more detail visit wfhummel.net/fedovervi....
>
>
>
>
The money to pay the interest comes from the Fed itself, which simply credits the bank's account at the Fed with a deposit of that amount.
On Dec 28 11:27 PM pbf123 wrote:
> But where is the 6% generated? 6% on the amount of money they have, even just 3% is a large amount.
The statistics have been compiled based on information provided by 12,000 corporate executives throughout the world. A system of rating the banking systems of individual countries was conducted by participants answering a number of questions and rating the banks on a scale of one to seven, one being in need of government support seven being entirely healthy.
Canada’s baking system, lead by Royal bank, CIBC, Scotiabank, TD Bank, Bank of Montreal and National Bank, received the highest rank in the world, scoring 6.8 on the rating scale.
The top 10 safest countries for banking are currently as follows:
Canada (6.8)
Sweden (6.7)
Luxembourg (6.7)
Australia (6.7)
Denmark (6.7)
Netherlands (6.7)
Belgium (6.6)
New Zealand (6.6)
Ireland (6.6)
Malta (6.6)