Currency

What Is Seigniorage?

In today's podcast we try to answer the question: Where is all the U.S. currency?

In it we mention that the U.S. government profits from the fact that people all over the world love our green pieces of paper.

How does the government actually profit? Through something called seigniorage, which is as hard to explain as it is to spell.

In the old days, seigniorage was the revenue the government earned because it costs less than a dollar to print a dollar. Say it costs 2 cents to print a $1 dollar bill. Then, poof, the government has gained something like 98 cents when it prints that dollar and uses it to buy something. That's overly simple but it's a good starting place.

Today the Federal Reserve controls the money supply. And one of the ways it does this is by buying or selling treasury bills. If the Fed wants to increase the money supply, it buys some treasury bills (government bonds) from banks. So a treasury bill is taken out of circulation and replaced, basically, with dollars. Presto. More dollars in the world.

Here's the key part: more dollars in circulation means more treasury bills at the Fed. And unlike dollars, the treasury bills earn interest. So the Fed profits. It's holding onto those treasury bills, which pay off with interest. Basically, when you hold onto U.S. cash, you're giving the Federal Reserve an interest-free loan.

Check out the wikipedia entry.

And here's a good explainer on what it's like to be the institution that can basically create money out of thin air.

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