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Sunday, October 15, 2017

Should We Care About Seigneurage?

I believe I have a better understanding of Eric Lonergan's arguments regarding whether fiat money is a liability of a state with currency sovereignty. (This discussion does not apply to commodity money, or a state using a money issued by an entity not under its direct control.) If I am correct, I would phrase his argument as: the existing accounting treatment of money is incorrect, since it does not account for seigneurage revenue. (Seigneurage has multiple English spellings; I was using the French spelling on Twitter -- seigneuriage.)

Aside: Should We Care About Governmental Accounting?

This discussion can easily be sidetracked by philosophical debates regarding the usefulness of governmental financial accounting. To be clear, I do not think that it is very meaningful.

What is meaningful for a government are two things:
  1. How is the government utilising real resources?
  2. What is the purchasing power of its money? (Although the state can be indifferent to inflation, the voting public is not. Furthermore, the private sector may replace the government-issued currency with something else if its purchasing power is too unreliable.)
Unfortunately, those are complicated questions to answer. Financial accounting offers us a shortcut, assuming the following things are true.
  1. The multiplier on all spending (that generates income in the private sector) and taxes is the same.
  2. There is a single price level in the economy.
  3. There is a monotonic relationship between economic growth and the effect on the price level. (Simply, more growth means a higher price level.)
These are assumptions that are embraced by most mainstream economists (which explains why they are happy looking at governmental financial accounting); in the heterodox view, some or all three of these points are incorrect.

However, the assumptions are not totally and completely wrong; we can use them to give directionally correct views on what will happen in extreme cases. For example, if the Canadian government handed out $1 million in cash to every Canadian citizen, the purchasing power of the Canadian dollar would collapse. This outcome can be predicted using traditional financial analysis -- the government blew out its financial spending capacity. (Conversely, this would be hard to predict using financial analysis if the "cash" were not a liability.)


The idea of seigneurage is that "money" (government liabilities that pay 0% interest) is a low-cost funding source in a world where we assume that interest rates are positive. (Money is the high-cost funding source in a world of negative interest rates!) Note that this is the definition of "money" I am using in this article; I do not care what other whack-job definitions other people can come up with. (Abolish it!)

There are two well-known instruments that qualify as "money" using this definition. (Note that this list is not exhaustive; any account payable with no associated interest rate would qualify.)
  1. Currency in circulation -- notes and coins.
  2. Required reserves held at the central bank, that pay 0% interest.
Please note that the Federal Reserve pays interest in settlement balances held in excess of reserve requirement ("excess reserves"). Although they are part of the "monetary base," they not longer qualify as "money" by this definition, which matters in the context of the discussion of seigneurage.

We can then define the estimated one-year seigneurage revenue as the interest saved over one year by replacing interest-paying government debt by "money." (If you insist on sticking excess reserves in your definition of "money," you then need to account for the interest you pay on excess reserves, making the exercise more complicated than what is shown here.) Since we do not know exactly what debt instruments would be replaced by "money," our best guess is the interest rate on Treasury bills over the year.

Note that the use of the word "revenue" is contentious; it's really an opportunity cost saving. I am just using it as a technical term that follows existing usage, it is definitely not a view about its proper accounting treatment.

I do not want to derail this article with a discussion of rate expectations and the choice of discount rates. I have opinions on those areas, but they are distraction. We will instead keep everything simple and assume that we are in a situation where all governmental interest rates (and discount rates) are flat at a strictly positive level. I will use 1% for simplicity, but any interest rate above 0% gets the same final result.

In our 1% world, "money" saves the government 1% per year versus governmental debt. We forecast this to occur for every year going forward ("to infinity"). Let's say we want to capitalise this stream of one-year seigneurage revenue. What is it worth?

An instrument that pays 1% per year perpetually is a consol with a 1% coupon. If its quoted yield is 1% (as by assumption), its price is $1 (for $1 face value).

 In other words, in a world of a perfectly flat yield curve (with a strictly positive yield), the capitalised seigneurage value of the stock of money is equal to the face value of the stock of money. If we argue that seigneurage revenue can be capitalised as an asset, it would be an asset on the balance sheet of the central bank that matches the liability value of the "money" stock.

If one wanted to cancel out the two entries, one might argue that the stock of money is no longer a net liability. However, this operation is an attempt to cancel out known liabilities with a definite face value with a model estimate using highly uncertain input parameters, and so many accountants would scream bloody murder about that.

(Furthermore, there is an additional financial saving associated with notes and coin: some of them get destroyed. If we could identify these instruments, they should be written off as liabilities. However, unless the government periodically redeems its currency outstanding, there is no good way to measure this effect. Having currency used overseas -- which is well-known attribute of the U.S. dollar -- might appear to make the liability disappear. From a functional finance standpoint, it does: such currency should not cause inflation in the United States in the short term. However, we can easily imagine policy changes that would cause such currency to return the territory of the United States, and hence the liability is still hanging over the government.)

Does This Work?

In the abstract, attempting to value seigneurage revenue is not objectionable. Any detailed simulation of debt dynamics needs to take this account into effect. For example, any DSGE model that has non-zero money holdings has to add a correction to the so-called inter-temporal governmental budget constraint to account for this. (The simpler DSGE models imply zero money holdings, so this effect is zero.)

Attempts to do real-world calculations of this effect probably give smaller numbers than the idealised example above. The explanation is that long-term discount rates have an upward bias relative to the true forecast of the path of short rates: the term premium. Treasury bill return underperformance of Treasury bonds is a known empirical regularity, and we use Treasury bond yields for long-term discounting. (Yes, it's internally consistent.)

The larger practical problems involve the use of a highly debatable estimate on a balance sheet, and whether "saving interest" is actually a form of revenue that can be capitalised. A bank would not be particularly amused by your attempt to capitalise Boxing Day Sale shopping savings on your loan application.

Unfortunately, No Policy Implications

In any event, there are effectively no policy implications associated with this analysis. Very simply, there is no way to force the private sector to voluntarily hold instruments yielding 0%. Yes, you can force the banking system to hold excess reserves that pay 0% (which was historically the case in the United States), but that just drives down Treasury bill rates to 0% as well. In that case, the one-year seigneurage revenue is $0, and a perpetual stream of $0 cash flows has a NPV of $0, regardless of interest rates.

Yes, required reserves (that pay 0%) are way of getting this cost saving. However, required reserves are just a tax on the formal banking sector, and you end up driving activity to the poorly regulated shadow banking system (that blows itself up, and needs to be bailed out). This net present value analysis is what bank lobbyists would use to value the cost of this tax.

The fact that the private sector is willing to hold notes and coin yielding 0% is a way to reduce interest expense, but that willingness is not enough to build a new economic theory around.

(c) Brian Romanchuk 2017


  1. I am trying to capture your underlying framework.

    I think we all agree that government has a choice of borrowing from private banks or borrowing from the CB.

    I think you believe that private banks can only loan reserves. This means that private bank loans do NOT create money.

    I think you believe that government DOES create reserves when government borrows from the CB. In this framework, the only way to create new money is to allow government to borrow from the CB.

    Using your 1% interest rate, you would value loans from the CB as if they had the discounted value of a consol with a 1% coupon.

    I think you assign the term 'seigneurage' only to earnings which here are a 1% coupon.

    I don't think you assign any value to the reserve increase caused by a G-CB loan. Where some authors assign a 'seigneurage' value equal to the reserve increase, you assign zero value. However, if government were to sell the reserve increase, it would have the discounted value found for a consol.

    Turning to liability, government would have a liability for these reserves (because it created them and then distributed them to the public as 'money' or deposits?).

    Do I have your underlying framework nearly correct?

    1. There’s nothing about the creation of liabilities. This is just the interest savings created by replacing debt that pays 1% with “money” - under my definition here, anything that pays 0% interest. Notes and coins, required reserves, etc.

      The asset value is the discounted value of the stream of interest savings.

  2. This is superb, Brian. Thank you.

  3. It pains me to admit that I don't understand this post. Perhaps being able to read Eric Lonergan's arguments would help?

    I am most confused on this part- "The idea of seigneurage is that "money" (government liabilities that pay 0% interest) is a low-cost funding source in a world where we assume that interest rates are positive. (Money is the high-cost funding source in a world of negative interest rates!)"

    Is that true? Even in a negative rate situation, the state has to return some amount of what it 'borrows'. How is it not a lower cost funding source to print $100 bills, or just 'keystroke' money into accounts, rather than setting up the whole arrangement of selling bonds even if at negative rates? Less bills (keystrokes?) needed over time?

    At least I agree with you here-"Very simply, there is no way to force the private sector to voluntarily hold instruments yielding 0%." I agree that there is no way to 'force' anyone to do something 'voluntarily'.

    1. To be somewhat harsh, it took a fair amount of work to translate Lonergan’s arguments into this form. Anyone familiar with seigneurage arguments will know this already (although I was unaware or forgot about the perfect cancellation if interest rates are flat). His arguments were hard to follow since he believes that the valuation arguments that I use here are too simplistic, and so he had to use more complex phrasings. However, once you get the basic principle down, you can add all the complexity to the calculation you want.

      You are over-thinking this. This “seigneurage revenue” - as I define it here - is just the interest savings for zero interest liabilities; nothing more, nothing less. (This is actually a pretty standard definition; other authors might jazz it up somehow.) The costs of maintaining the system, printing' etc., are ignored. I wrote this like a math paper: I gave a definition for the term, and you have to look only at that definition - and ignore whatever else you want the term to mean.

  4. So you are defining seigneurage as being only the interest a government could earn if it created some amount of money and loaned it out? That has never been my understanding of the word, but I guess you can define it that way for the purposes of this argument. Not sure why you would want to do that though. Why ignore the $99+ purchasing power of a newly created $100 bill that costs less than a dollar to make?

    Cullen Roche is also commenting on Lonergan. I don't know what Cullen is thinking when he says private bank money is just as trustworthy as government money. That is just the case because the government guarantees it. It wouldn't be otherwise.

    Anyways, where are these arguments from Lonergan to be found? I found his blog using google and he had 2 recent posts on MMT, but these don't seem to be what either you or Cullen are referring to.

    1. It’s just interest saving. The face value creation is immaterial - the government also creates the face value of debt “for free”. Worrying about the printing cost is a very low order issue, other than for low-denomination. And yes, people can define seigneurage to include other factors - not the concern here. If they want, they need to value those other factors.

      Lonergan’s arguments were over 100’s of tweets, and his old debate with Randall Wray. Not exactly an easy source to follow.

      Cullen Roche has a thing going that “MMT is wrong, because banks.” Like all the other MMT writers, I am very well aware about the facts about banks that Cullen Roche raises, yet I do not care about them. That is, he thinks they are important, I don’t. Not a fruitful area of debate, so I do not worry about it.

    2. Ok, thanks. I won't worry about understanding Lonergan then because I don't follow twitter. As for Cullen Roche, I have read him for a number of years and really don't see any significant distinction between what he writes and what MMT says. So I won't worry about that either. As far as I can see it amounts to arguing whether seigneurage is the same as seigniorage :)

    3. Yeah, this was my version of reading between the lines on his tweets. He had a long form argument with Randall Wray (I wrote about it), but this interpretation was obscured.

      Cullen Roche has a political beef with MMT, on top of his theoretical concerns. As I wrote in an earlier article, we need a free market wing of MMT in order for it to be competitive as a theoretical framework. What constitutes a “school of thought” seems to depend upon a person’s viewpoint. I take a very wide view, and like you, I have a hard time to see a difference between what he writes, and MMT. Sure, there’s some technical points he raises, but I consider them to be secondary. If we wanted to be strict in dividing schools of thought, my views probably constitute “Romanchukianism,” which is frankly ridiculous to think about.

  5. Eric Lonergan published a blog article entitled: Accounting as religion: Buffett, Derrida, and MMT. In this article he argues that "money" is not a liability of the state or central bank. I provide the most relevant complete quote below the link:

    Quote: "Now it is true that cash and reserves are not ‘owned’ by the central bank, so it cannot claim that they are assets. But the ability to create them is obviously hugely valuable – to the state and the society it represents. The best way to think about money created by the state is the production of a ‘liquidity service’. Liquidity is extremely valuable to a modern financial system and economy – and the government is monopoly provider of the purest liquidity. Base money creation should really be showing up on the central bank’s income statement as a sale of liquidity services. Every time a central bank buys bonds and creates reserves there should be an equivalent increase in its revenues, which given the zero cost of production, will translate into an equivalent increase in its profits, and an equivalent increase in its equity. Balance sheets will still balance, of course – accounting makes sure they do – but the convention will be a more accurate representation of the reality."

    This 26 page paper is the best reference I have found when considering the accounting principles (philosophy) of how to treat intangible assets:

    If I understand EL he is saying that "money" is an intangible asset with "network effects" or (a more common term) "positive externalities." I agree but don't think it is sensible to treat the issue of money or bonds as income to the government which would then become equity on the government balance sheet when the books close in each accounting period.

    Another way to see it is that the central government can issue more liabilities than it holds in financial assets - the difference would be booked to negative equity - and the financial asset of the private sector and local governments is simply the book value of negative equity of the government. This does not capture the value of intangible network effects but it does allow money to be created in a "tangible medium of expression" by recording government liabilities using traditional accounting customs.


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