What is seigniorage, and how is it related to competition to become the key reserve currency? Provide 3 examples
Using from Husted, S. L., & Melvin, M. (2010). Chapter 19. In International economics (8th ed., pp. 484-486). Boston, MA: Addison-Wesley.
All answers must be to the question, not “all I know about the subject.” All Answers must include recent examples. Answer cannot exceed one page (single space standard margin).
In the years past, seigniorage simply denoted revenue earned by the government through the production of currency. The aspect is underlined by the fact that it costs less than a dollar to produce one. For example, a 1 cent cost of production would illuminate on a 99 cent per dollar profit. However, the inherent definition is not as simply advanced. The passage of time has served to encompass other money-making channels availed through money supply control options. An epitome of the aspect can be seen in the engagement of the Federal Reserve in the sale or purchase of treasury bills and bonds (The Wall Street Journal, 2017). Increased purchase by the treasury increases the amount of dollars in circulation around the globe. In retrospect, treasury bills earn an interest rate, unlike currency. The federal reserve earns from the vague form of an interest-free loan by the masses.
Further, the term monetary seigniorage points to the ability of the government to borrow without an intrinsic nee to repay. Part of the approaches to the same point to the aspect of debt monetization. In debt monetization, the Federal Reserve could manipulate money supply in case of a robust Gross Domestic Product (GDP). In addition, the monetization could aim to satiate the set inflation targets. The aspect of inflation control can be attained through manipulation currency in tandem with the laws of demand and supply. Simply put, inflation denotes a situation of excess currency chasing a few products: Aspects attained by currency control.
The ability of the Federal Reserve to make profits through currency manipulation, and the government in general, leads to an inherent battle to attaining the position of a key reserve currency. The reserve (anchor) currency signifies the amount of currency held by countries, through their respective institutions, in lieu of foreign exchange reserves. Post the Bretton Woods system, the U.S. Dollar still serves as a reserve currency in the larger parts of the world. Partly, the strength of the dollar originates from the fact that it has never been devalued or invalidated (Borensztein & Berg, 2000). In lieu of the previous definition and explanation on seigniorage, a reserve currency points to extensive power of the Federal Reserve to make profits devoid of large costs.
Extensive examples of seigniorage can be seen across the globe. For example, a continued demand for the U.S currency signifies increased profits. Most natural resources are priced in terms of dollars. Key among resources is the sale of oil around the world. In addition, other regimes around the world price imports and exports in dollars. The fluctuations of the currency values, in relation to a country’s economies, would enable the use to make profits through trade purchases. Across the globe, transactions in pursuit can be seen at work across the major economies. The illustrations are inherent in China, the European Union, and the United Kingdom’s monetary regimes. China has sought to devalue its currency to attain a status as a part of the world’s reserve currencies (Investopedia, 2017). On an individual level, exchange of gold for currency, and with a rise in value for gold, indirectly contributes to the creation of seigniorage. However, the tenet holds if the individual in perspective resorts to buying back gold, but at the current market rates. In specific examples, the Federal Reserve engaged in extensive open market operations after the 2008 recession through the purchase of treasuries and securities (Harrison, 2017). The above aspects denote the making of profits through currency creation and profits attained through the purchase of various assets.
Borensztein, E., & Berg, A. (2000). Full Dollarization: The Pros and Cons. Washington D.C.: International Monetary Fund.
Harrison, D. (2017, June 14). Fed Unveils Plans to Shrink Its Balance Sheet. Retrieved from The Wall Street Journal: https://www.wsj.com/articles/fed-unveils-plans-to-shrink-balance-sheet-1497464483
Investopedia. (2017, October 16). The Impact of China Devaluing the Yuan. Retrieved from Investopedia: https://www.investopedia.com/trading/chinese-devaluation-yuan/
The Wall Street Journal. (2017). Market Data Center. Retrieved from The Wall Street Journal: http://www.wsj.com/mdc/public/page/2_3022-bondoffer.html