Making Money from Making Money Seigniorage in the Modern Economy
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MAKING MONEY FROM MAKING MONEY SEIGNIORAGE IN THE MODERN ECONOMY NEW ECONOMICS FOUNDATION MAKING MONEY FROM MAKING MONEY CONTENTS EXECUTIVE SUMMARY 2 1. INTRODUCTION 4 1.1 WHAT IS MONEY? 5 1.2 HOW IS MONEY INTRODUCED INTO THE ECONOMY? 8 2. STATE SEIGNIORAGE: NOTES, COINS, AND RESERVES 12 2.1 BANKNOTES 13 2.2 COINS 14 2.3 CENTRAL BANK RESERVES 14 3. MODERN COMMERCIAL BANK SEIGNIORAGE 17 3.1 THEORY OF COMMERCIAL BANK SEIGNIORAGE 18 3.2 COMMERCIAL BANK SEIGNIORAGE IN THE UK 20 3.3 COMMERCIAL BANK SEIGNIORAGE IN DENMARK, SWITZERLAND, AND ICELAND 22 3.4 DISCUSSION OF RESULTS 24 4. DIGITAL CENTRAL BANK CURRENCY: IMPLICATIONS FOR SEIGNIORAGE 27 4.1 CALCULATING STATE SEIGNIORAGE WITH CENTRAL BANK DIGITAL CURRENCY 29 5. CONCLUSION 32 APPENDICES 34 APPENDIX I: BANK SOLVENCY AND LIQUIDITY 34 APPENDIX II: DATA SOURCES 35 APPENDIX III: CALCULATING STATE SEIGNIORAGE WITH CENTRAL BANK DIGITAL CURRENCY 38 ENDNOTES 40 NEW ECONOMICS FOUNDATION MAKING MONEY FROM MAKING MONEY SUMMARY Seigniorage has traditionally been understood as the difference between the cost of physically producing Who has control money and its purchasing power in over the supply of the economy – a £10 note for example costs just a few pence to produce so new money and seigniorage profits are likely to be close what benefits does it to £10. Historically it was sovereign bring? There is now states who had the exclusive power to create and spend money in to the widespread acceptance economy: the term seigniorage derives that in modern from the French seignior which means economies, commercial sovereign ruler or feudal Lord. banks, rather than the In modern economies, such as the central bank or state, UK, however, money in circulation created by the state – physical cash – create the majority of only represents around 3% of the total the money supply. money supply. The remaining 97% is lent in to economies as the digital IOUs of commercial banks – the deposits that This report examines are entered in to our bank accounts ‘seigniorage’ – the when banks make new loans. profits that are This report develops a model of generated through commercial bank seigniorage based on the reality that banks, unlike the creation of money. other financial intermediaries such as Peer2Peer (P2P) lending platforms, do We show that in the not have to acquire funds in the first instance before making loans. This is UK, commercial bank because banks’ IOUs – bank deposits seigniorage profits – have been privileged by the state amount to a hidden as having the status of money which people must hold to make payments in annual subsidy of £23 the economy. billion, representing For the UK, we calculate that this 73% of banks’ profits privilege has provided commercial after provisions banks with seigniorage profits and taxes. amounting to an annual average of £23 billion per year in the 1998–2016 period. This is equivalent to 1.23% of GDP. In contrast, state seigniorage – profits generated by central banks via the issuance of banknotes – has only amounted to £1.2 billion a year. We also examine commercial bank seigniorage in three other countries where there are active debates about monetary reform: Denmark, Switzerland, and Iceland (Table 1). 2 NEW ECONOMICS FOUNDATION MAKING MONEY FROM MAKING MONEY TABLE 1. COMMERCIAL BANK SEIGNIORAGE ACROSS FOUR COUNTRIES COUNTRY PERIOD AVERAGE ANNUAL AS % OF CUMULATIVE STUDIED COMMERCIAL BANK GDP COMMERCIAL BANK SEIGNIORAGE SEIGNIORAGE UK 1998–2016 £23.3 billion 1.23% £443 billion Denmark 1991–2015 DKK11.7 billion 0.7% DKK293.4 billion Switzerland 2007–2015 CHF2.8 billion 0.6% CHF34.8 billion Iceland 2004–2015 ISK14.1 billion 0.9% ISK169.7 billion The findings suggest that a large lending or charge higher interest proportion of banks’ profits are rates. However, most bank lending underpinned by their control over in advanced economies flows in to the money supply, an essential piece commercial and domestic property and of public infrastructure. Should the other financial assets rather than to public take back some control over businesses. Seigniorage profits could be the creation of money? A number of seen as another form of public subsidy economists and civil society groups for the banking sector, supporting have argued that the central bank excessive pay and non-value-creating should create a higher proportion – lending that contributes to rising house or all – of the money supply. And a price and financial-asset prices. number of central banks, including the Bank of England and the Swedish This means there is a strong case for central bank, are examining whether returning a portion of seigniorage they should begin issuing central bank profits to the public purse by digital currency (CBDC). This would introducing CBDC. Such a move could allow households and firms to directly also provide other advantages. It would hold digital money with central banks create some genuine competition rather than with commercial banks. for the commercial banks in the payment services sector, levelling the Such a move could lead to a major playing field for non-bank financial increase in central bank seigniorage intermediaries such as P2P lenders profits that would normally be and the ‘Fin-tech’ sector and giving the reimbursed to the tax payer along with public a genuinely safe way of holding a corresponding decline in commercial its money. And it would give central bank seigniorage. For example, in the banks a new channel to more directly UK case, we find that £182 billion of stimulate the economy when necessary, cumulative seigniorage profits would for example via crediting households have accrued to the public purse since with ‘helicopter money’ or governments 1998 if 30% of the money supply had via ‘monetary financing’. Finally, it been in the form of digital central bank could help make the payments system currency rather than commercial bank and broader financial system more deposits. This profit would have been resilient to economic shocks. paid to HM Treasury and could have been used to support public priorities Overall, such a reform would be a step or reduce the government deficit. towards democratising a monetary system which – via seigniorage profits Commercial banks might argue that – gives commercial banks a major reductions in their seigniorage profits subsidy that puts them in a uniquely would lead them to contract their privileged position in the economy. 3 NEW ECONOMICS FOUNDATION MAKING MONEY FROM MAKING MONEY 1. INTRODUCTION Historically, issuing money has been a royal prerogative, and the C resulting purchasing power accrued reating new money is to the seigneur1 or ruler. The revenue a profitable business. earned from the issuance of new Money costs very little money – the difference between the purchasing power and the cost of to produce, and yet producing the money – was referred it commands a value to as seigniorage.2,3 It can be viewed as revenue in the sense that it increases many times this in the the spending power of the sovereign economy. in the same way as an increase in taxation does. This terminology survives to this day, and in discussing A £10 note costs just a seigniorage, most economists still work few pennies to print but on the assumption that the state has a can be used to purchase monopoly on the creation of money. £10 worth of goods This concept of seigniorage is no and services. For digital longer adequate to explain the modern monetary system. For in modern money, created by economies, most money is created not simply tapping numbers by central banks or any other state into a computer, the body, but by private commercial banks. Because commercial banks create difference between the money in the act of lending, the profits cost of creating money generated from money creation are different from the traditional notion and its purchasing of seigniorage. They instead relate to power is even greater. the interest profits banks make due to their ability to issue debt that is used as money, in contrast to every Those organisations other person and organisation in the to whom society has economy whose liabilities are not granted the power money. This report examines who benefits from the modern process of to create new money money creation and the scale on which therefore have a they benefit. privilege not enjoyed This question is important and topical. by anyone else in There is currently a lively debate about the economy. the ‘end of cash’ with an increasing number of payments being conducted by commercial banks online, via mobile phones, or with debit or credit cards.4,5 In the UK, the Bank of England is conducting research into whether it might be appropriate for a central bank to issue digital cash rather than limit itself to the production of physical notes and coins.6,7,8 4 NEW ECONOMICS FOUNDATION MAKING MONEY FROM MAKING MONEY The financial crisis of 2008/2009 This report is intended to be a helpful raised serious questions over addition to these international debates. whether commercial banks should be the primary determinants of Given that seigniorage is revenue the creation and allocation of the accrued through the creation of money, money supply. Much of the money any concept of seigniorage necessarily created by commercial banks went has to make an assumption about into supporting the purchase of real what money is and how it is created. estate and financial assets rather We therefore begin by examining the than to businesses supporting the question of what money is and how it real economy and creating growth is introduced into the economy. and jobs. This led to the build-up of unsustainable levels of debt in these 1.1 WHAT IS MONEY? sectors, which is now preventing a return to stronger economic growth.9 Most people use money every day, and Thus, the question of who should many go to great lengths to acquire create money and benefit from its it.