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The silence is deafening.

Yesterday, Scott Sumner asked me how Seigniorage works.  There had been some confusion in previous comments about how this works (which was mostly my fault due to a typo in one comment) so I wrote a detailed post on the subject.  Scott responded saying:

“Cullen, You wrote a deeply silly post. Why not just admit that you didn’t understand how the Fed earns seignorage? Instead you write a post claiming I don’t understand how seignorage is earned.

When you write multiple paragraphs explaining how it’s the Treasury that issues currency and earns seignorage, and not the Fed, then it’s no longer a typo.”

So, Scott thinks not only that the Treasury doesn’t produce any currency, but that the seigniorage from this currency doesn’t benefit it.  First, let’s just get the Fed’s view on this (via the Richmond Fed FAQ):

“Does the Federal Reserve produce bank notes and coins? 
No, the Federal Reserve does not produce bank notes or coins. The Bureau of Engraving and Printing (BEP) produces currency and stamps, and the U.S. Mint produces our nation’s coins. The Federal Reserve issues Federal Reserve notes and places them in circulation.”

In case you’re wondering: “currency in circulation—that is, U.S. coins and paper currency in the hands of the public”. The US Mint issues coins at face value.  Okay, so Scott is obviously wrong about issuance of currency (though the Fed does issue FR Notes).   But what about seigniorage?  I responded again explaining the process of how almost all seigniorage is a Treasury benefit, which directly contradicts his claims.   He said nothing.  Probably because he disagrees with the idea that “it’s the Treasury that issues currency and earns seigniorage”.

Let’s be clear about this.  First, Seigniorage is “income a government derives from the difference in the face value of a monetary unit and the cost to produce it.”   It should not be controversial that coins are produced by the Mint and sold at face value to the Reserve Banks.  It also should not be controversial that cash is produced by the Bureau of Engraving and sold at cost.  From there, calculating seigniorage is simple.  JKH (who, let’s be honest, understands this stuff better than Scott or I do) explained it nicely in a comment yesterday:

“The cleanest way to look at it is to consider the pre-2008 Fed, when it was running a ‘clean’ balance sheet.

The banks come into the Fed for more currency – because their customers are demanding it.

The Fed debits the banks’ reserves and issues the currency.

On a pre-2008 basis, the Fed is then required to replace those reserves (for interest rate control), which it does by going out and buying bonds.

The net result is that the Fed’s balance sheet expands by bonds on the asset side and currency on the liability side.

The interest rate differential between those two generates the seigniorage profits over time.

The cost of purchasing the notes from BPE is an operating cost which I suppose could be considered as a deduction from the gross seigniorage benefit. But it is relatively small, and charged upfront as a one time expense – as opposed to the core interest margin stream that starts cranking up and goes forever.

Looking at the private sector consolidated balance sheet, what is really happening on a net basis is that the private sector is swapping bonds for currency as the monetary base grows. Deposits actually remain unchanged for the most part – because those who sell the bonds to the Fed get deposits in exchange. The owners of the deposits change, but not the macro profile. Treasury is issuing bonds to fund the deficit over time, and the CB is steadily converting the effective cost of a portion of that bond financing into zero cost currency.

Seigniorage is a direct Treasury benefit in the case of coins and a direct Central Bank benefit in the case of notes. Consolidate the fiscal effect, and its all a Treasury benefit, as Cullen described.”

So, as I said, seigniorage is a benefit to the Treasury primarily, which would contradict the way Scott Sumner thinks this all works.  Which is pretty weird considering he’s the expert on monetary policy and I am just a lowly market practitioner.

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