Tuesday, 12 July 2016
Seigniorage profits made by private banks.
Seigniorage is defined in the Oxford Dictionary of Economics (2009) as “The profits made by a ruler from issuing money”. I suggest the word “ruler” is superfluous there. I.e. seigniorage is the profit made by ANYONE who issues or prints money, including for example, a backstreet counterfeiter. At any rate, I’ll use the word in the latter sense.
As to how backstreet or traditional counterfeiters make a profit, that’s obvious enough: they print $100 bills for example and buy consumer goodies with those bills. I.e. they get $100 worth of real goods in exchange for a piece paper. Nice work if you can get it.
But private banks also issue a form of money. As the opening sentence of a Bank of England article entitled “Money creation in the modern economy” puts it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.”
However, private banks clearly do not do the same thing as traditional counterfeiters: use the money they create to buy consumer goodies. Instead, they lend out that money at interest.
So is there any sort of seigniorage profit there? Well the answer is: yes. The way that profit comes about was explained in a rather stylized way by Messers Huber and Robertson in their work “Creating New Money”.
As they put it, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0%debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”
That explanation by Huber and Robertson is unrealistic, and doubtless deliberately so. Banks do not of course lend to the majority of borrowers at the normal rate, and lend to another lot at 4% less than the normal rate. Rather, the ability of private banks to create a certain amount of new money almost every year enables them to lend at a lower rate than if they had to obtain money the way most of us do: doing some sort of work and saving up.
And no doubt competition between banks means that lower rate is enjoyed to some extent by borrowers rather than all of it going straight to banks’ bottom line.
But the fact remains, that private banks’ freedom to print money benefits those banks, and those they lend to.
So who loses out?
There are no free lunches in this world. I.e. the latter extra profit for banks and borrowers must come from somewhere. And where it comes from is not too difficult to work out.
Assume, just to keep things simple, that the economy is at capacity (i.e. full employment) prior to private banks being granted the right to create money. Assume that banks are then granted the latter right. The extra lending will boost demand. But that’s not permissible without inflation rising too much, given the above assumption that the economy is already at capacity.
So to counteract the inflationary effect of that new borrowing, government would have to implement some sort of DEFLATIONARY measure, like raising taxes or cutting public spending. In that case, those paying for the above increased bank profits and reduced interest for borrowers would be taxpayers or the recipients of public spending.
An alternative would be for the central bank to raise interest rates. But to do that, taxes would have to be raised there as well - to pay for the interest going to those with cash to spare who decided to buy the new state issued high interest bonds. So again, taxpayers pay a price.
Private banks do actually make seigniorage profits but no quite in the same way as traditional counterfeiters. In the case of private banks, the profit is earned in much more circuitous way.
I’ll leave the last word to the French economics Nobel laureate, Maurice Allais:
“In reality, the ‘miracles’ performed by credit are fundamentally comparable to the ‘miracles’ an association of counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases, the stimulus to the economy would be the same, and the only difference is who benefits."