By Brian Lang

One of the key advantages of cash versus cashless forms of payment is that it generates an income for governments, which is known as seigniorage (also also spelt seignorage or seigneurage). This little-understand and even less-publicised form of income is generally defined as the net revenue derived from the using of banknote and coins. Brian Lang, formerly of the Reserve Bank of New Zealand, provides a more explicit definition, as well as examining the differences between notes and coins, some of the issues surrounding seigniorage and the substantial values that are involved.

Seigniorage income that accrues to the state or monarch has been around a long time. During the era of metal-based money, the monetary base consisted of precious metals produced by the public and converted into coins by the state. The difference between the face value of the coins and the cost of acquiring the metals and minting them generated a financial benefit for the state or reigning monarch.

The 2006/07 annual report of the Reserve Bank of New Zealand describes seigniorage as ...'the income directly associated with the issue of currency and provides the Bank with its main source of income. Private sector owned banks pay the Central Bank the face value of currency issued to them. These funds are invested in an investment portfolio; New Zealand Government securities and foreign currency assets. Currency in circulation is a non-interest bearing liability, however, the investment portfolio is interest bearing. The resultant interest income is seigniorage'.

Value of Seigniorage

In the 2006/07 financial year the RBNZ disclosed seigniorage income of NZ$226m. After deducting the operating expenses for the currency function (note and coin issue costs and processing/distribution expenses), the operating surplus is NZ$208m. After other Bank income and expenses are included a dividend of NZ$193m was paid into the government's consolidated fund.

In the US the 2007 annual report of the Federal Reserve System identified interest income of approximately US$39 billion. The system paid the US Department of the Treasury more than US$34 billion as interest on Federal Reserve banknotes. As a major reserve currency, a significant portion of this income results from seigniorage earnings on the proceeds of banknotes held outside the US.

It is rather harder to assess the income from the US dollar's nearest rival, namely the euro, as neither the ECB nor the NCBs disclose this information. The situation is further complicated by the fact that the involvement of the NCBs in the cash cycle (and, therefore, their cost of cash in circulation) differs from country to country, as does the method of calculating production costs for banknotes (eg the costs of in-house production versus purchasing notes on the free market).

In essence, however, seignorage is distributed to NCBs by the ECB according to a formula based on the GDP and number of inhabitants of each. As an estimate, in 2006, cash in circulation was EUR 700 billion. At an interest rate at the time of around 4%, seigniorage can be estimated around EUR 27 billion. But this was gross revenue, whereas net revenue was estimated to be around EUR 10 billion.

In a nutshell, central banks have the statutory right to issue banknotes, that is, in an accounting sense functioning as a debtor for the value of banknotes in circulation. The face value of the notes will be recorded as a liability on the central bank's balance sheet, matched by a corresponding asset; in other words the community provides an interest free loan to the central bank, which in turn invests these funds in income producing assets.

It is this income, derived from issuing banknotes, that is known as 'seigniorage'.

Tax on Public

In some senses, seigniorage is also a tax on the public. The public must give value for the currency or coins that it uses as a means of payment or store of value. The holder of currency or coins earns no return on them. The income that the central bank earns on investments purchased with the proceeds of currency and coins is not shared or returned to taxpayers directly. Thus seigniorage can also be seen as value taken from the public and applied to funding the operations of the central bank or the government.

Seigniorage income enables a central bank to be self-funding and financially independent of government. This is an important consideration in countries where the central bank has been given a mandate to control inflation by using monetary policy tools. In most countries a major part of the central bank's net revenue is transferred to the state.

Differences for Coins

While interest bearing assets corresponding to banknotes in circulation are a source for permanent income for central banks and indirectly for the state, coins in most countries are issued by the government and only brought into circulation via the central bank distribution system. In this case the state, as in ancient times, is the direct beneficiary of the difference between face value and production cost including materials.

Thus, seigniorage from the issue of coins does not provide permanent income, as in an accounting sense the value of coins in circulation is treated as a contingent liability. The annual revenue of the state in this case depends on the annual growth of coins in circulation.

Issues Around Seigniorage

There are a number of issues around seigniorage. These may include how a government or central bank manages the issue of a denomination that is producing 'negative seigniorage' (when the production cost is higher than face value) or how a central bank accounts for and spends seigniorage income (should it be used to subsidise the distribution of the product?); If seigniorage income is declining will central banks begin to actively promote the use of cash over other forms of payment?

These issues will be discussed in future articles on this subject.

(Any views or opinions expressed are solely those of the author).