Learn All About Seigniorage
Is Seigniorage a new term? Get acquainted with the term and its implications.
What Is The Seigniorage All About?
The difference between the face value of money such as a $10 bill or a quarter coin and the cost to produce it is known as Seigniorage. Thereby in other words, the economic cost of producing a currency within a given economy or country is much lower than the actual exchange value generally accruing to governments who mint money.
It is noted that if the Seigniorage is positive, the government will make an economic profit while a negative one results in an economic loss.
The Seigniorage Explained
Counted as revenue for a government it is when the money it creates is worth more than it costs to produce that Seigniorage is important. Therefore the revenue is often used by governments to finance portions of their expenditures without having to collect taxes. As for an example, it costs the US government 5 cents to produce $1, the Seigniorage is 95 cents or the difference between the two amounts. Hereby Seigniorage gives a country the potential to turn a profit when it produces money.
Here it is that while the definition of Seigniorage is most often the difference between that cost of printing new currency, as well as the face value of that, ’s same currency, which is also the number of goods or services a government can acquire through the printing of new notes.
What About Seigniorage And Losses
Eventually there are some situations in which the production of currency can result in a loss instead of a gain for the government creating the currency with the loss being more commonly experienced in the production of coins because the metal used to produce the coins has inherent value. While this value is often called the melt value, it may be higher than the denomination it originally represented or when combined with production costs, it may result in a loss. Hereby the example is the US penny that was shown to cost 1.5 cents with a face value of 1cent.
Thereby overtime the melt value may also change as market demands shift with potentially leading to the value of the metal being worth more than the face value of the currency with an example occurring silver coins such as the US silver quarter and the silver dime.
The Connection Between Seigniorage And The Federal Reserve
While it is known that the basic principle behind Seigniorage suggests that a country can surely profit from the production of new bills, it is also observed that there can be other factors affecting the entire transaction. It’s here that the Federal Reserve has agreed to increase the number of dollars available within the US economy purchasing a treasury bill in exchange for permitting the production of more dollars. It is true that while the government may appear to profit when the cost of production is lower than the face value of the bills, it’s still noted that treasury bills require interest payments to the federal reserve in addition to the original investment placed when the treasury bill was purchased.
Here it is important to know that Gresham’s law is a monetary principle stating that bad money drives out good. It was originally based on the composition of minted coins and the value of the precious metals used in them. It is therefore in other words, in case a gold coin is worth $ 5, and a silver coin is worth $0.50 as people hoard the gold coin and instead exchange10 silver coins. Here the gold coins drop out of circulation and the bad money drives out the good. It becomes a form of effective Seigniorage since the gold becomes worth more even though its face value is the same as10 silver coins. It is however the abandonment of metallic currency standards that the theory has been applied to the relative stability of different currencies’ value in global markets.
Finally Concluding With A Real World Example
While it was based on anticipated demand for a new currency that the Federal Reserve places an order annually that is with the department of the treasury’s Bureau of Engraving and Printing and pays for production costs. Thereafter the Fed provides detailed information on each currency denomination and the cost to produce it, for example it costs11.5 cents to produce a $20 note, and 14.2 cents to produce a $100 bill.
Thereby the US mint is responsible for coin production influenced by the number of requested Federal Reserve Bank orders where the Federal Reserve purchases the coins at face value.