What Is Seigniorage?
Seigniorage is the difference between the face value of money, such as a $10 bill or a quarter coin, and the cost to produce it. In other words, the economic cost of producing a currency within a given economy or country is lower than the actual exchange value, which generally accrues to governments who mint the money.
If the seigniorage is positive, the government will make an economic profit; while a negative seigniorage will result in an economic loss.
- Seigniorage is the difference in face value of money, such as a $0.25 quarter coin, and the cost to produce it.
- Seigniorage may be counted as positive revenue for a government when the money it creates is worth more than it costs to produce.
- In some situations, the production of currency can result in a loss instead of a gain for the government creating the currency (e.g. producing copper pennies).
Seigniorage may be counted as revenue for a government when the money it creates is worth more than it costs to produce. This revenue is often used by governments to finance portions of their expenditures without having to collect taxes. If, for example, it costs the U.S. government 5 cents to produce $1, the seigniorage is 95 cents or the difference between the two amounts. Seigniorage gives a country the potential to turn a profit when it produces money.
While the definition of seigniorage is most often the difference between the cost of printing new currency and the face value of that same currency, it is also the number of goods or services a government can acquire through the printing of new notes.
Seigniorage and Losses
In some situations, the production of currency can result in a loss instead of a gain for the government creating the currency. This loss is more commonly experienced in the production of coins because the metal used to produce the coin has inherent value. This value, often called the melt value, may be higher than the denomination it originally represented; or, when combined with production costs, may result in a loss. For example, the U.S. penny was shown to cost 1.5 cents in 2016 with a face value of 1 cent.
Over time, the melt value may also change as market demands shift, and it can potentially lead to the value of the metal being worth more than the face value of the currency. An example occurs in silver coins, such as the U.S. silver quarter and the silver dime.
Seigniorage and the Federal Reserve
While the basic principle behind seigniorage suggests that a country can profit from the production of new bills, there can be other factors affecting the entire transaction. If the Federal Reserve agrees to increase the number of dollars available within the U.S. economy, it will purchase a Treasury Bill in exchange for permitting the production of more dollars. While the government may appear to profit when the cost of production is lower than the face value of the bills, it is important to note that Treasury Bills require interest payments to the Federal Reserve in addition to the original investment placed when the Treasury Bill was purchased.
Gresham's law is a monetary principle stating that "bad money drives out good." Gresham’s law was originally based on the composition of minted coins and the value of the precious metals used in them. In other words, if a gold coin is worth $5 and a silver coin is worth $0.50, people will hoard the gold coin and instead exchange 10 silver coins. As a result, the gold coins drop out of circulation and the bad money (the silver) drives out the good (the gold). This becomes a form of effective seignorage since the gold becomes worth more even though its face value is the same as 10 silver coins. However, since the abandonment of metallic currency standards, the theory has been applied to the relative stability of different currencies' value in global markets.
Real World Example
Based on anticipated demand for new currency, the Federal Reserve places an order annually with the Department of the Treasury's Bureau of Engraving and Printing and pays for production costs. The Fed provides detailed information on each currency denomination and the cost to produce it. In 2019, for example, it cost 11.5 cents to produce a $20 note, and 14.2 cents to produce a $100 bill.
The U.S. mint is responsible for coin production, which is influenced by the number of requested Federal Reserve Bank orders. The Federal Reserve then purchases the coins at face value.