Do private banks make seignorage profits?

The word seignorage is not defined in exactly the same way in every dictionary. But the word will be used here to refer to the profit that is made by a money issuer or money printer .

The simplest and crudest example is the profit that a backstreet counterfeiter makes: counterfeiters print bits of paper and use them to buy goods and services of real value. Nice work if you can get it.

Governments (and/or their central banks) do much the same: they create new money and use that to buy infrastructure investments, schools, war ships and so on. Of course no one objects to the seignorage there because the latter assets are shared by the community at large.

Certainly where recipients of that money are prepared to hold the money without demanding interest (and holders of £10 notes, $100 bills don’t get interest), government makes a seignorage profit. As to where government has to pay interest to recipients of that money, then essentially government funds its spending by borrowing, and there is no real seignorage profit.


Fontana and Sawyer.

Commercial banks certainly create money, but are they also into seignorage?

Messers Fontana and Sawyer claim in a recent paper entitled “Full Reserve Banking: More ‘Cranks’ Than Brave Heretics” that commercial banks do not enjoy seignorage.  As they put it, “Graziani (2003, pp. 58–66), among others, has explained that no agent involved in the loans supply process has a seigniorage privilege: not businesses, not households, and certainly not commercial banks.”

Fontana and Sawyer do not actually produce any detailed reasons as to why commercial banks do not enjoy seignorage. Instead, as the above passage implies, they rely on a long passage in a book by Augusto Graziani – “The Monetary Theory of Production”. So let’s consider Graziani’s arguments.

The first glaring weakness in Graziani’s argument is that he DEFINES money, or at least his ideal form of money as something that does not involve seignorage!

Well I can prove that boats don’t float using my own special definition of the word boat which is something like “anything that sinks”!

The relevant words of Graziani’s are (his p.60), “A real money should satisfy three main characteristics . . .”. And one of these is that “the use of money must be so regulated as to give no privilege of seigniorage to any agent.”

Moreover, since governments clearly enjoy seignorage, it would seem that Graziani does not regard base money as money, which is strange idea. Last time I tried buying stuff with £10 notes, the shop accepted by £10 notes!

Graziani’s basic argument is that the simple / basic / obvious activity of banks involves no seignorage, which is correct. That basic activity is that a bank creates and lends money to person X as needed so that X can pay Y for goods or services supplied. Y then deposits the money at Y’s bank, which in turn demands payment (in the form of base money) from X’s bank. Clearly there is no seignorage profit there for either bank.

In the case of private banks, it is much less clear whether and if so how they make seignorage profits. However, Huber (2000) explains pretty clearly how they do it in this simple illustration.

“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.”

Of course private banks do not lend to one lot of borrowers at the free market rate and to another lot at the artificially low rate that comes from lending out freshly printed money, as is rather suggested in Huber’s simple illustration. Rather, private banks use the freedom to print money to lend at a lower rate than would otherwise obtain, and that expands the total amount of lending they do. The profit derived from that extra business is certainly seignorage profit of a sort: i.e. it is profit derived from money printing.