Steve Bain

What is Seigniorage in Economics?

Seigniorage is the term used by economists to describe the way in which a government can create currency at almost no cost to itself, but at significant cost to the general public.

As the government spends the money it creates on its various programs, it causes price inflation to rise because the extra money added to the economy exceeds the value of the extra goods and services its programs create. That excess of new monetary units circulating in the economy, over and above the value of new products, serves to create price inflation as the extra money competes to purchase scarce products.

This gives rise to the term 'inflation tax' because the costs of currency creation are real, and it is the people who suffer those costs rather than the government.

Note that I referred to the creation of currency rather than money. Currency is easy for a government (or monetary authority such as the Federal Reserve Bank) to create when that currency is not backed by anything. If the currency is backed by something real, like gold, then creating more money (relative to gold) will undermine that backing and force the government to reverse its policy.

Fiat currency has always had this weakness, because it is not backed by anything other than the government's promises, and those promises are routinely broken whenever the government's own interests are at odds with the interests of the economy.

Seigniorage Since 2008

A convincing case can be made that the government has knowingly been operating a policy of seigniorage at least since the 2008 financial crisis. The policy of quantitative easing (QE) since that time has led to the creation of vast amounts of extra currency which has been pumped into the financial system to prevent the big banks from going bankrupt.

In the US, the banks had lent heavily in the years running up to the financial crisis in the form of mortgage lending. Mortgage-backed securities were then created and traded throughout the financial system. The problem with this is that the housing and real estate sector entered into a massive boom, with property prices rising way above their long-term sustainable levels.

When the property market crashed, many homeowners were faced with mortgages that were larger than the value of their homes. There were even some people who had only been paying their mortgage costs by remortgaging their homes each time property prices rose, and then using the extra borrowed funds to pay for a lavish lifestyle.

With property prices falling in 2008, all that had to end, and the result was a great deal of mortgage default. The implication of that was that the mortgage-backed securities floating around the financial system were now undermined, and the problem was so extensive that it threatened to destroy the banking system.

QE was introduced soon after, and this fancy term was no more than a transfer of money from taxpayers to reckless mortgage lenders in exchange for worthless mortgage-backed securities.

In effect, rather than face the inevitable severe economic downturn that would have occurred following the crisis, along with a great deal of voter discontent, the government saved its own neck and threw the taxpayer under the bus.

QE is basically seigniorage by a different name, and while the inevitable inflation tax that follows such policies remained under lock and key for over a decade, it finally presented itself in 2021. The Fed did what it does best and totally underestimated it, declaring it transitory, but the inflation genie was finally out of the bottle.

The rising food and energy prices in 2021 are being felt most by the least well off in society, but the beneficiaries of the seigniorage policy i.e. the post financial crisis Obama government and the reckless bankers, all did well. The whole episode was a clear example of a  government looking after its own interests first - anyone in the way of that is merely collateral damage.

Inflation Tax Effects on the Classes

The cost of seigniorage i.e., the inflation tax that it creates, falls disproportionately on some members of society. This is best understood in a simple step by step example.

  • New currency is printed and spent by the government on one of its projects.
  • The recipients of that expenditure receive the currency before it has had time to circulate around the economy and cause inflation, and therefore receive currency with full purchasing power.
  • The currency is either spent, or deposited where it can earn interest.
  • Deposited money gets loaned out and circulates through the economy causing some price inflation.
  • At each stage of circulation, the purchasing power of each unit of currency is further reduced due to increasing inflation.
  • By the time the full effects of inflation have worked through the economy, its impact will be felt most by regular people who did not directly benefit during the early stages.

As you imagine, the early recipients of the newly printed currency benefit. Anyone who borrows money at an early stage (on a fixed interest rate) will find that the real cost of his/her debt repayments are eroded away. Savers, on the other hand, will find the value of the savings eroded by inflation.

This is the real injustice of inflation, the disproportionate way in which it hits some people hard while actually benefiting other people.

Typically it is the poor and middle classes who get hurt, because it is they who borrow the least and save the most. The rich are the main beneficiaries. Believe it or not, it is the rich who are often the biggest debtors, this is because they can borrow at rates low enough for them to profit from capital investment of borrowed funds.

I have written more about this in my main article about:

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