What Is Seigniorage and Does It Cause Inflation? With Example
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 cost of producing a currency within a given economy or country is lower than the actual exchange value, which generally accrues to governments that mint the money.
If the seigniorage is positive, the government will make a profit; a negative seigniorage will result in a loss.
Key Takeaways
- Seigniorage is the difference between the face value of money—both paper bills and coins—and what it costs 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.
Understanding Seigniorage
Seigniorage is 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.
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 coins 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, with a face value of one cent, cost 2.10 cents to produce in 2021—the sixteenth year in a row that production costs exceeded the penny’s face value.
Over time, the melt value can 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. One example is silver coins, such as the U.S. silver quarter and the silver dime.
Real World Example of Seigniorage
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 2022 for example, it cost 13.8 cents to produce a $20 bill, and 17 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.
$1 billion
The Federal Reserve’s currency operating budget in 2022.
Special Considerations
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 (T-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.
Seigniorage and Gresham’s Law
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 thus the bad money (the silver) drives out the good (the gold).
This becomes a form of effective seigniorage 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.
What Are the Origins of Seigniorage?
The origins of the term seigniorage date back to the days of feudal lords in Europe. Those who were “seigneurs” or lords had the authority to mint coins.
How Much Does It Cost to Produce a Dollar Bill?
The cost to produce a U.S. dollar in 2022 is 7.5 cents. This means the seigniorage is 92.5 cents per dollar bill.
How Many Coins Does the U.S. Mint Produce?
In 2021, the U.S. Mint produced more than 14 billion circulating coins. Circulating coins, such as the penny, nickel, dime, and quarter, are defined as those used for everyday transactions. The U.S. Mint also produces commemorative coins and precious metal coins.
The Bottom Line
Seigniorage allows governments to earn revenue when the face value of money is more than the cost to produce it. The revenue is typically used to fund expenditures without having to collect taxes.
Sometimes the production of currency can result in a loss instead of a gain. This is the case with the U.S. penny, which costs 2.10 cents to produce. The U.S. dollar, on the other hand, costs 7.5 cents to produce, resulting in a seigniorage of 92.5 cents.