Submission for Canadian Political Science Association Annual Conference
The Rehabilitation of Seigniorage
Seigniorage is the profit that accrues to the issuing authority when money is created.
To explain and illustrate full seigniorage, let me present a scenario, "the case of the perfect counterfeiter." Imagine a counterfeiter of such sublime skill that he will never be caught and his bills will never be distinguishable from official banknotes. Like the feudal lords who, legend holds, had the right of initial deflowering of their serfs' brides, our perfect counterfeiter has the privilege of the first spending of the monetary creation; in other words, first-crack privilege; in other words full seigniorage. After that, his creation gets spent and re-spent – money is not a chaste wife – as it blends indistinguishably with the rest of the money supply.
Of course, our counterfeiter would be enriching himself unfairly and illegally, and would be deserving of moral condemnation and imprisonment. Yet, if the government and financial institutions were reluctant to print new money, our crook might be performing valuable service to the economy: injecting fresh blood in the circulatory system. However, if there were a large number of perfect counterfeiters, the system would be flooded by this monetary blood. Since their activities would create money, but not goods or services on which to spend that money, the extra liquidity could only be counterbalanced by raising the price of goods and services. That is, by creating inflation. Now, a little inflation is okay. Pensioners can afford to lose a few dollars (almost by definition) but runaway inflation is bad for everybody. Who wants to wake up to the realization that he lost half his wealth overnight?
It is this possibly of hyperinflation that has given seigniorage a bad name. In the 30's, the Weimar Republic of Germany, in an effort to fulfil the unreasonable war reparations imposed by the Treaty of Versailles, started printing money hand over fist. It got so bad that employers would lengthen lunch hour so that workers could go spend their money before it lost even more of its purchasing power. There were stories of people going to the bank with wheelbarrows to hold their money.
More recently we have witnessed runaway inflation in Argentina, caused, again, by the government's vain attempt to deal with massive debilitating debt. In this case the debt was not due to war reparations but rather to the good-boy assent by Argentina to "sound" economic rules enforced by the World Bank and the International Monetary Fund, including the supposedly "wise" decision to peg its money rigidly to the American dollar.
But not all uses of seigniorage lead to economic collapse. During World War II, the Bank of Canada created approximately 50% of new money (for which there was a crying need, considering that the country was going to war and just emerging from a long recession). This money was spent on the war effort by the government and therefore represented full seigniorage on that 50% of new money. Again, after the "first-crack" spending by the government, the money wended its way through the aggregate of economic transactions. (Note that most of that money was not expressed in currency, but rather in checks, letters of credit, book entries and other forms of scriptural money). The Canadian economy did not collapse and no corporation was forced into bankruptcy.
The Untied States is in a unique position to profit from seigniorage. When, in 1975, President Nixon ended the monetary system known as gold exchange standard by ending the convertibility into gold of the American dollar, the later practically replaced gold as the international standard of exchange. Under the previous system, the US dollar had become the principal reserve currency, but the US had pledged to exchange any non-citizen' dollars into gold at a fixed price ($35/ounce). But with the annulment of this pledge, the US mint became a virtual gold mine (except that the dollar was itself subject to fluctuations).
There are many ways for the US to profit from its privileged position.
For example:
Suppose that Canada and the United States independently decided to monetize their national debt by creating enough currency and scriptural money to pay off their creditors. Canada could only do this with the part of the debt that is denominated in Canadian dollars, the part that is denominated in foreign money (mostly US) could not be monetized because the creditors would not accept Canadian money as payment. The United States government, however, could monetize its whole indebtedness because its money is universally accepted. The American government would get the benefit of full seigniorage on whatever currency or scriptural money it would create for that purpose.
Every country needs to accumulate and save American dollars in order to participate in the global economy. How can it acquire them? – By exchanging goods for them, that's how. America can sustain extremely high trade deficits, year after year, because it gets the goods it imports for free – or almost.
[As a left-winger, I neither like nor endorse this system, but I expound on it only to show that seigniorage can work to a country's benefit. Note, though, that this particular scheme is not foolproof. It is only its general acceptance worldwide that allows it to work. Should many countries and institutions start preferring, say, the Euro to the dollar, the United States could lose most of its seigniorage.]
Why is it that in two of the above examples the recourse to seigniorage was unsuccessful, and in the other two cases it worked? – The failures were destined to be so because money was created to take care of a money problem. The successes were so because money was created to manufacture or purchase goods and services – especially goods. Therefore, the money fabricated was absorbed by real transactions and excessive inflation was avoided.
It is crucial to remember that all economic systems are the children of barter. Barter is our Old Testament and when we forget that we stray into bad economic religion. Seigniorage will not lead to hyperinflation if we establish the principle and maintain the practice of two-way convertibility: money converting into goods and goods converting into money, which is as close as we can get to the spirit of barter without losing the many advantages of modern economics and technology.
When a salesman sells a good – say, an automobile – he converts a good into money, but when a government fabricates money for a creative purpose – say to produce added-value goods from wood – it is doing the opposite: it is converting money into goods (assuming of course that there is both a need and a demand for the products). As long as the principle of two-way convertibility is followed, there is little chance that seigniorage will lead to runaway inflation.
But if a government manufactures great quantities of money in an attempt to deal with money problems – huge debts, massive deficits, debilitating interest payments, etc. – then hyperinflation is sure to follow, because the principle of two-way convertibility has not been respected. If Argentina had used seigniorage in a creative way all along, instead of incurring unpayable debts (and trying to pay them – another mistake) and of following the strong-armed "suggestions" of the World bank and the IMF, they would not have been practically forced to use seigniorage in a panicky attempt to wiggle out of its straits. Good seigniorage would have prevented bad seigniorage; respecting two-way convertibility would have prevented hyperinflation.
We must not think of seigniorage as a sure-fire miracle cure, even when it is practiced by well-meaning and intelligent people. There are necessary preconditions:
- There must exist a minimum of natural resources.
- There must be a minimum of human resources (with an ethos favorable to work and discipline, and some level of literacy in some part of the population).
- There must be a minimal level of infrastructure, including governance and management, transportation, and an embryonic educational system capable of preparing citizens for the coming changes.
There is one caveat that conservative economists would certainly point out: Wouldn't it be necessary to also invent money to finance the purchase of these goods and wouldn't this double generation of money lead to inflation? In other words, if money has to be created to finance the production of goods, and if more money has to be fabricated to finance the purchase of these goods, wouldn't the economic system drown in too much money?
Jean-Baptiste Say, in the early 19th century, and Henry Ford, a hundred years later, provided a partial refutation of this argument: workers must be paid a fair wage (at least in liberal societies) and this money will necessarily be spent to satisfy their needs. Workers are also consumers. Ford insisted on building cars that his workers could afford. Therefore, the same dollars that are created for production will partially finance the purchase of this production.
There is more to the refutation of the argument, but first we must digress and touch on the topic of services. Goods and services are very often mentioned in the same breath, but more often than not,
I have referred to goods without mentioning its twin, services. They are twins, but not identical twins. Besides the obvious distinction, on that one deals with physical things and the other with activities performed by humans, animals, and machines, there is another important difference: the supply of goods is limited by the availability of natural resources whereas the supply of services is potentially infinite. One can always invent a new service and try to sell it. The supply of putative services is bound only by the capacity for creativity and by the natural limitations of humans, animals and machines.
This elasticity is good but dangerous because, with seigniorage, the potential supply of money is also practically infinite. In the absence of caution and discipline, these two potential infinities can easily lead to runaway inflation.
There is another danger: some services have the potential of a real payoff, but only after a long period of incubation. Education and preventive medicine are two examples. Between the creation of the funds needed to start and maintain such programs, and their eventual payoff there is room for much inflation. Yet, we should not be too timorous: when Gandhi founded the Indian Institutions of Technology, it must have seemed a foolish move in a third world, mostly unindustrialized country; but today India is reaping great rewards from this initiative.
But the good side of the service sector is far from negligible. Say's law asserts that there can never be excess production because, collectively, workers spend their income on the consumption of the goods they produce. In reality, there are so many leakages and externalities that this law is of no practical import. But the service sector can make up for the shortcomings of Say's theories. Money created for the implementation of services for which there is a need and demand will quickly be used by the service workers for the purchase of commodities (and services). Say's law can thus be made to work. It's a matter of balance, but isn't all economics a matter of balance?
Goods have priority over services. Without denying the spiritual part of our nature, and without touting conspicuous consumption and moneylatry, it must be admitted that we are primarily physical entities living in a physical world. Economics can deal with humans who are both physical and spiritual; it can deal with purely physical beings, but it cannot deal with purely spiritual entities. Even mystics need their icons, beads, prayer mats, books, or whatever objects they use to connect to the spiritual. Services themselves, including education, are usually dependent to some extent on material things: tools, of course, but also roads (big asphalt ribbons), vehicles, buildings, books, computers, and so on. On an even more basic level, our very survival depends of the availability of physical things: food, air, water; fuel for heat; wood and ceramics for shelter. The infrastructure of a society has both a physical component and a mental one (laws, programs, etc.) [At this point, the reader should mentally go back to my previous references to goods and substitute goods (and services), the parentheses being used to help keep in mind the above prioritization.]
The implementation of seigniorage programs must be examined under two perspectives, the tactical and the strategic:
Comparatively short-term, individual projects are fairly straightforward: as long as the principle of two-way convertibility is respected, so that goods (and services) will balance the money creation, there should be no major problem, providing that the dangers due to the elasticity of the supply of services are kept in mind. All money is a form of credit: seigniorage just gives this aspect of money more importance. In both tactical and strategic endeavors, money should be no problem. If the enterprise makes sense;
if the plan is intelligent and realistic; if the ecological costs and other externalities are taken into consideration; and especially, if the two-way convertability of money is maintained.
Note that the classical expression, supply and demand, leaves out a factor that governments cannot neglect: need. Need and demand do not always coincide. The need for environmental laws for outstrip the popular demand for them. There must be certain demand for whoopee cushions -- since novelty stores sell them – but feww would insist that there is a need for them. Money should be created for the production of goods (and the promotion of services) for which there is both a need and a demand.
The strategic aspect is more complex. Seigniorage empowers a society to realize, in the foreseeable future, any realistic positive vision it may have of itself, because – if everything else is right – money is no object. To ascertain that a vision is realistic some questions must be pondered:
1. Do we have the natural resources needed?
2. Do we have the human resources?
3. Will our existing infrastructure support our programs?
4. Can we limit and control the ecological costs and other externalities?
5. If it happens that our activities, in spite of our precautions, are causing excessive inflation, can we take money out of circulation?
The first three questions must be answered positively; the last two are more nuanced. The externalities of question 4 include possible hidden and unforeseeable consequences of policies and decisions, hence the impossibility of a definite a priori yes answer. However, many such problems can be prevented with a little foresight. For example you do not plan to export luxury goods to a country what is expected to be involved shortly in major warfare; you do not exploit a mine if, as a result, you will pollute a major river and adjoining farmland; you do not use a fishing technique that is very effective for a certain fish, if it is harmful to other important fisheries; you do not engage in an enterprise if the activity would offend the local population for cultural or religious reasons, even though the venture would be economically profitable.
Question 5 can only be touched upon in this paper:
Money is not wealth. Too much of it can diminish wealth. Money is now very easy to create: banks do it, ex nihilo, every time the grant a loan or buy a security. (The kind of seigniorage I recommend would create less money than does our present financial system.) Textbooks explain the bookkeeping procedures and entries by which this scriptural money is created (only 5% of the money supply is in currency); but no book explains how this manna is destroyed. They simply say that the money is erased as the loan is repaid; but what is created by a bookkeeping algorithm must be killed by a bookkeeping algorithm.
Psychologically, killing money is not an easy thing to do. God, they claim, gives life and God takes life. In a scheme based on seigniorage, the Central Bank creates money, and the Central Bank kills it – but only some of it and only when necessary. By whatever means – loan repayments to the Central Bank, taxes, rent on public land, royalties on resources, profit-sharing arrangements, etc. – some of the money must end up in the coffers of the Central Bank. As the money supply churns and circulates through the economy, a portion of it should always be caught up in the Central Bank whirlpool. The latter can simply sit on it until there is a need to reinject it in the economy, or kill it by means of an open and verifiable accounting algorithm. This last procedure could even be performed on a specified day (we could call it Potlatch Day), yearly or bi-yearly. There would be no reason to worry about erasing too much money, since in a system permitting seigniorage, money can always be creates when needed, as long as the principle of two-way convertability and other caveats are respected.
But who makes the decision that the conditions and the timing are right for the creation of x amount of new money for project y? Can one individual such as the Governor of the Bank of Canada, or the chairman of the Reserve System take on the responsibility? – I think not. What we need is an appointed committee of wise men /women, such as the Open Market Committee of the Fed, or the Council of Economic Advisors. Such a group should be large enough to accommodate different interests and points of view, but not so large as to become a debating club, unable to come to decisions. It should, of course, contain experts from the financial world,but, also some members representing other interests and perspectives. Certainly, the head of the Central Bank and the Minster of Finance (or the equivalent) must be included. A path to follow for submissions for funds would be established, such as (for example only): local government, private company or NGO –> to government agency (ministry, department, etc.) –> to the committee of wise men/women –> to the Central Bank.
Seigniorage need not be 100% nor immediate. For example:
As we have seen above, banks and other financial institutions invent from thin air, the money that they lend. The government, through the Central Bank, should create that money.
Let me suggest a workable scheme:
When a bank grants a loan it borrows the principle from the Central Bank, which is mandated to create the money and lend it to the bank at zero interest. As the loan is repaid to the bank, the latter repays the Central Bank, thus profiting only from the interest (as is supposed to be the case).
This would constitute deferred seigniorage going to the government, but would not induce any inflation and no more money would be crated than is presently invented by our financial institutions. Should it come to pass that banks had been recuperating some or all of the principle of their loans all along and therefore would become insolvent once deprived of this manna, the Central Bank could apply negative interest. A $10,000 loan at –10% interest would be liquidated upon repayment of $9,000. The Central Bank and the private bank would thus share the seigniorage in a ratio of 9 to 1.
There are many possible schemes by which full or partial seigniorage can be garnered. Some of them would be more adaptable to left-wing governments, other to rightwing or centrist regimes. Developing countries could use seigniorage to escape the grasp of the World Band, the I.M.F. and other denatured Bretton Woods institutions.
Emerging economies can make progress faster if they use seigniorage from a left-wing perspective. A planned and managed economy can improve the living conditions of people much faster than one based on private enterprise. Privatization and entrepreneurship can be progressively introduce later until an optimal balance between pubic and private initiative is reached.
It is baffling that politicians have not realized that seigniorage can allow them to implement good projects without incurring the wrath of the population, which can be inspected when taxes are increased. Compared to taxes seigniorage is "ouchless."
And we do need taxes. Seigniorage can lighten the burden, but it cannot eliminate it. Taxes do more than fund the public enterprise: they can redistribute wealth, and they can be a tool for controlling the flow of money. They are one means of bringing part of the money supply under the control of the government. Since seigniorage can replace much of the tax revenue that would accrue to the money-creating institution – the federal government – it gives more tax-collecting power to states/provinces and to local governments, thus alleviating the unfunded mandate problem.
Last words:
It will be objected that seigniorage is a dangerous concept that can lead to hyperinflation. There are dangers, but they are moderate compared to the dangers represented by neoimperialism, global corporatism and a system that creates trillions of dollars that are unconnected to the world of work, goods and services. The economic cowboys are not on the side of the promoters of sensible seigniorage, but on the side of current global finance.
Finally, never forget the two-way convertibility principle. If you do, you might as well forget about seigniorage.
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