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.)

Seigneurage

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