America is hardly workshop to the world. Germany and China both have us beat in gross exports despite much smaller overall economies. In net terms, of course, we take and the world makes. But we do have some strong export products, including a surprising one—cold hard cash. American currency may not have the snazzy colors or variety of shapes and sizes that alternative money has to offer, but it’s the world’s most popular medium of exchange. With about about $1 trillion in notes and coins outstanding relative to a gigantic $14 trillion American economy, cash is something of a bit player but still nothing to sneer at. The Federal Reserve estimates that most of this money is held abroad rather than in American wallets and mattresses. Foreigners, in other words, just can’t get their hands on enough dead presidents.
At first blush this just sounds like trivia, but it has some very real consequences for the American economy. This money functions, quite literally, as an export allowing Americans to possess hundreds of billions of dollars worth of goods and services that we couldn’t otherwise afford.
The technical term for this is seigniorage, derived from the French word for a lord, and it refers in general to the financial privileges that accrue to an issuer of currency. The crudest form of seigniorage dates back to the days when currency took the form of metal coins. The classic British pound sterling, for example, was actually made of sterling silver. But its silver content was only 92.5 percent with the remainder composed of base metals. That 7.5 percentage point gap between face value and actual silver content represented seigniorage to the crown. Take such debasement too far, of course, and ruinous inflation may result. But in its day a certain amount of seigniorage was a reasonable way to raise some revenue and ensure the availability of a sufficient quantity of coinage.
A different form of seigniorage was associated with the gold standard era. In those days, a paper note was “backed” by gold, meaning that, in principle, you could show up and demand that the government give you gold in exchange for your money.
In those days, central banks operated in much the same way as conventional banks. A credible government could and would issue more currency than it had gold. This worked because carrying paper bills is much more convenient than carrying gold around, so on any given day most people would treat their money as “as good as gold” with no particular desire to redeem it. But this too opened up a gap between what the government was capable of purchasing and how much gold it truly held, a new form of seigniorage. During the First World War, participating governments resorted extensively to this form of monetary finance to the extent that credibility collapsed and nation after nation faced runs on their gold reserves. Rather than surrender, countries simply abandoned gold convertibility. In the postwar years, much effort was expended on restarting the gold system. When the Great Depression hit, however, it turned out that abandoning gold in order to allow governments to print and spend more money was highly effective and rebooting growth.
Seigniorage under the postwar “fiat money” system is in some ways the most straightforward. It takes much less than $20 worth of real resources to produce a little piece of paper with Andrew Jackson’s face on it, so the more $20 bills the government prints the more money it makes. The penny, which costs 2.4 cents to make, and the nickel, which costs a whopping 11.2 cents, are interesting forms of anti-seigniorage that President Obama’s latest budget proposes to cut down on by shifting to cheaper metals.
The United States as a whole, however, can’t enrich itself over the long-term by printing money (in a steep recession, monetization should work as a form of stimulus) without the cooperation of foreigners. This is where modern seigniorage comes into play. For foreigners to have gotten their hands on hundreds of billions of dollars worth of American currency, they have to have sold us hundreds of billions of dollars worth of real goods and services. In exchange we gave them paper that doesn’t even work as legal tender where they are. Who are these people, and why don’t they invest their money in something that pays interest? They turn out to come in two broad classes—people who live in countries with unreliable banking systems (boring), and criminals. Money-laundering is difficult, costly, and often requires smuggling money into specific countries which puts a premium on large denominations of widely used bills. The central role that large stockpiles rather than everyday transactions play in the cash economy helps explain why Franklins rather than the more widely seen Jacksons account for about 75 percent of the value of outstanding currency. All this currency circulating abroad amounts to a giant, enduring interest-free loan to the American consumer.
But the party may be over soon. When the Euro was launched in 2003 it included a 500 euro bank note that constitutes a much more efficient medium of illicit exchange. This whopper of a bill took Europe’s backyard by storm, leading the United Kingdom to ban exchange offices from selling the 500 back in 2010, as a way of cracking down on organized crime. At the time the Serious Organized Crime Agency claimed that 90 percent of €500 notes sold in Britain were in the hands of organized crime. In the Eurozone itself, the tax evasion problems in Greece and other Southern European countries are already the stuff of legend and large denomination bills are a big help here. So far, the €500 hasn’t displaced old-fashioned Benjamins globally. But if the euro survives the continent’s current turmoil, confidence in its long-term viability will increase. Slowly but surely, logic should push cash-lovers in that direction and Americans will have to say farewell to our seigniorage heyday.