Seigniorage
The term, "seigniorage", is defined [1] as "the difference between the [face] value of money and the cost to produce it - in other words, the economic cost of producing a currency within a given economy". This term is misunderstood frequently. It is sometimes used to encompass all income (imagined or actual) accruing to the Federal Reserve banks, their member commercial banks, or the US Treasury. This would include not only an allegation that the Federal Reserve pockets seigniorage on the FRNs printed at a cost of a few cents each and valued in the economy at full face value, but also interest made on bank loans. This is wrong. Seigniorage is simply a noun defined strictly as stated above. It carries no implication of profit; it is simply a mathematical difference between face value and cost. Interest on loans has nothing to do with it.
If the agency that provides the currency to commercial banks, be it a central bank or the government, is permitted to pocket this difference, then there is profit made on the seigniorage in supplying currency. If this is the law, then from the providing agency's perspective it is a pure sale with no implied requirement to redeem currency at face value ever. Such currency would not be legal tender for all debts public and private, because the initial supplier will not accept it as a bank deposit or as payment for any debt. It is sold by the authorized agent once, and all subsequent transactions are between private parties--provided the public perceives value in these notes. (And why would they see value in them if the central bank won't redeem them?)
In the case of the US Federal Reserve (FR) monetary system all outstanding currency in the hands of the public is, by law, a face-value liability of the FR and an obligation of the US government.
Understanding the mechanics of FRN transactions
It is helpful to use double-entry accounting T-accounts to illustrate the transactions involving currency and understand their implications within our FR monetary system. As transactions occur between two entities in the system, the balance sheets of the two (among the FR, the US Treasury, the commercial banks, and the checkable bank accounts of the public) change from one balanced state to another. The balance sheet of an entity has two columns. The left column lists assets, and the right column lists liabilities. The sum of the assets must equal the sum of the liabilities. The booklet, Modern Money Mechanics, published in 1961 and still available here: http://lisgi1.engr.ccny.cuny.edu/~makse/Modern_Money_Mechanics.pdf, shows how T-accounts are useful in this kind of analysis. The approach taken in this article illustrates the changes in balance sheets that occur when FRNs change hands as the FRNs proceed from printing to final destruction at the end of their useful life.
Birth of FRNs
FRNs are printed by the BEP of the US Treasury on order from the FR. They are not money at this stage. This kind of transaction is not a balance-sheet[2] transaction. It is an income-statement-sheet transaction. So there is no change in the balance sheets of the Treasury or the FR. This is important to understand.
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