What is Seigniorage in Finance

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Seigniorage is the direct financial benefit arising in the issuance of currency. And when it is obtained from notes it becomes more indirect, on account of the variation between interest realized on securities acquired, as a result of an interchange involving bank notes.

In the case of bank money, it is only the second-tier banks (commercial banks) that possess the privilege of issuing currency in the form of credits, thus enjoy the financial  benefits of seigniorage. It is equal to the difference between the cost of managing checking accounts and interest rate of refinancing with the central bank.

Seigniorage is viewed as a variant of inflation tax, because paying for government services using new currency (as opposed to gathering taxes from the available money stock), tends to produce a de facto tax effect which befalls those holding the current currency, due to its devaluation as a result of the injection of additional money.

In the beginning, seigniorage was the capital gain realized during the transformation of a quantity of metal coins. Any owner of gold or silver could process it and derive added value which comes from the cost of processing, this subsequently afforded the gold owner authority, especially in the context of a monopoly issue.

Normally seigniorage relates to an interest free loan advanced to the issuer of the coin or paper money. In the event that the currency gets worn out, the issuer repurchases it at face value. Thus equilibrating the revenue realized following its release into circulation, minus any extra amount as regards the interest value of what the issuer obtained.

Major central banks are governed by monetary operations guidelines which regard bank notes as the interest payments obtained by the reserve bank on the total sum of currency provided. Although, when the currency is retrieved temporarily or permanently out of circulation, the currency is never brought back to the reserve bank. Therefore, the issuer of the currency retains the entire seigniorage net profit, by simply cancelling repurchases of depreciated currency at face value.

An extremely profitable form of seignorage pertains to the global circulation of banknotes. At the same time the expenses involved in the printing of banknotes is low. And when it comes to international trade, the foreign merchants supply goods and services on the basis of note’s face value.

The bank notes’ circulation outside their native currency area is synonymous with large volumes, and reasons for utilizing foreign currency pertains to the store of value factor, and the performance of private transactions, which are sometimes illegal.

 

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