In memory of Dr. Andreas Höfert

The importance of seignorage in the US

Years ago, while I was in my second year of economic studies, I was surprised to learn that, in some poor countries whose governments collected very little revenue, not much more than import or export taxes, “seigniorage” financed a large part of public outlays.

This term comes from the Middle Ages, when feudal lords (in French “seigneurs”) had the monopolistic privilege of minting coins. It refers to the revenue they could extract from this privilege when the nominal or face value of a coin didn’t correspond to the real or metal value of the coin.

Thus in poor countries a large part of public revenue comes from the government monopoly on printing bank notes. As a consequence, inflation in those countries runs relatively high. In fact, their inflation rates can be interpreted as a monetary tax levied by the government on the whole economy. I remember a classroom exercise in which I had to calculate the “optimal” inflation rate for those countries, i.e. the one that would maximize their public revenues.

Having questioned my professor about the situation in more advanced economies, I learned that income from seigniorage, though it still exists, represents only a tiny portion of public revenues for them. Is this still true today?

Let’s look at the US. According to the Congressional Budget Office, the 2013 federal deficit will be 845 billion dollars. So who will lend the US government this kind of money? Japan, which holds more than a trillion dollars’ worth of US Treasury bonds? Maybe. Since the new Japanese government wants the Bank of Japan (BoJ) to buy open-ended financial assets until inflation there reaches 2%, it would indeed be possible for Japan to buy some US debt. However, I suspect the BoJ will focus on buying Japanese government debt, which has soared to almost 240% of GDP.

China is another candidate. It too holds more than a trillion dollars of US Treasury bonds. However, I don’t see China as a buyer. For the past two years the Chinese haven’t increased their Treasury holdings, not only because of their markedly reduced trade surpluses but because of their desire to diversify their reserve assets in the direction of precious metals.

In fact, it is the Federal Reserve that will absorb the bulk of the US Treasury market thanks to its quantitative easing program, through which it buys 45 billion dollars’ worth of government bonds a month. For 2013 alone these purchases will total USD 540bn or roughly two-thirds of the overall expected public deficit. It represents 3.5% of US GDP and 80% of the defense budget. Given those numbers, it is understandable that some people are worrying about the prospects for inflation in the US and have begun to compare the world’s largest economy with that of a developing country.