the issuing states, and are reported as a component of public debt under their respective national accounting statistics (ESA, 2010). Similarly, banknotes issued by central banks, and by extension central bank reserves (which represent the largest share of money base in every contemporary economy), are considered as liabilities of the issuing central banks and are accounted for as central bank debt to their holders.
By Biagio Bossone e Massimo Costa
In fact, even though the law says that money is “debt”, a correct application of the general principles of accounting does raise deep doubts about such a conception of money. Debt typically involves an obligation between lender and borrower as contracting parties. We wonder which obligation may fall upon the state from the rights entertained by the holders of coins, or which obligation may fall upon the central bank from the rights entertained by the holders of banknotes or by the banks holding reserves.
We specifically refer to these three “species” of money because they are all “legal tender”, that is, in force of a legal power, they absolve their issuers of any responsibility to convert them into other forms of value. This is not the case, obviously, for monies that are convertible on demand into commodities or liabilities issued by third parties (e.g., currencies of other countries). On the other hand, conversion of reserves into banknotes does not constitute a central bank’s debt obligation, since it only gives rise to a substitution of one form of liability for another that is issued by the same central bank and is not redeemable in any other form of value produced by third parties.
A similar question can be asked with respect to the money issued by commercial banks in the form of sight deposits, inasmuch as this money plays a similar role to that of legal tender in almost all bank-customer relations (excluding interbank obligations, which require central bank money as settlement asset). We shall return to this type of money later on in the article. Below we focus on legal tender monies issued by the state or the central bank.
Legal tender: if it is not debt, what else is it?
In the old days, local sovereigns guaranteed that the coins they issued contained a specific amount of precious metal (silver or gold). Still in those days, banknotes gave their holders the right to claim for their conversion into silver or gold coins. To be able to match those claims, sovereigns needed to hold adequate volumes of metal reserves. The same kind of obligation committed central banks with respect to their reserve liabilities issued to commercial banks. Therefore, all three species of money gave origin to true debt obligations that were legally binding on their issuers and could be triggered on demand by their holders at any point in time.
But this was the past. Today, convertibility has all but disappeared for each of the three money species under discussion. Coins have lost most of their relevance and have been largely replaced by paper money. Convertibility of banknotes has been suspended long ago, and the abandonment of the gold-exchange standard, about half a century ago, marked the definitive demise of “debt” banknotes even at the international level. Finally, the reserve deposits held by commercial banks and national treasuries at central banks are today delinked from any conversion obligation into commodities or third-party liabilities (except where the central bank adheres to fixed exchange rate arrangements, the economy is dollarized, or the country is under a currency board regime).
Therefore, although for legacy reasons, or simply due to conventional choice, money is still allocated as debt in public finance statistics and central bank financial statements, it is not debt in the sense of carrying obligations that imply creditor rights. Rather, it represents equity for the issuer and, as such, it implies ownership rights.
The “Accounting View” of money
Issuing legal tender involves a sui generis transaction whereby the money is sold in exchange for other assets. The proceeds from this sale represent a form of income, specifically a ‘revenue income’. Issuing legal tender thus generates revenue income to the issuer. Under current accounting practices, this income is (incorrectly) unreported in the income statement of the central bank, and is instead (incorrectly) set aside under the central bank’s ‘liabilities’.
When money is issued by a public entity, the associated revenue income accrues to the entity’s owners: the citizens. When, on the other hand, money is issued by a privately owned central bank, the revenue income accrues to the central bank’s private owners. If it is not distributed to the owners, the revenue income goes into retained earnings and becomes equity.
The assimilation of money to equity requires going beyond the conventional distinction between equity and liabilities, as is typically applied to investigate the nature of financial instruments. A correct application of the principles of general accounting recognizes that money accepted as legal tender is not a financial instrument as defined by the international accounting standards, and therefore cannot be debt. IAS 32 defines a ‘financial instrument’ as “a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity”, and defines an ‘equity instrument’ as “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities” (par. 11). Under these definitions, legal tender money is not a financial instrument, and it is neither ‘credit’ for its holder nor ‘debt’ for its
issuer. Instead, it is net wealth for the holder and net worth (equity) for the issuer.
Money accounted for as equity of the issuing entity implies ownership rights. These rights must not be understood as giving money holders possession over the entity issuing the money (as shares giving investors ownership of a company or residual claims on the company’s net assets). Rather, they are the same as those acquired by consumers purchasing goods by firms, since selling a commodity that grants specific utility to consumers is not conceptually dissimilar from selling an instrument that grants its acquirers a general type of utility – that of settling financial obligations.
Thus, the ownership rights attached to money as equity consist of claims on shares of national wealth that money holders may exercise at any time. Those who receive money acquire additional and definitive purchasing power on national wealth. Those issuing money get in exchange a form of gross revenue that is equal to its nominal value. The revenue income calculated as the difference between the gross revenue from money issuance and the cost of producing money is a rent universally known as ‘seigniorage’. This special form of rent can be appropriated exclusively by those who hold the power to issue money, or are granted such power.
To summarize, our proposed ‘Accounting View’ of money holds that:
· Money circulating in the economy as legal tender is not a financial instrument - it is neither credit for the holders nor debt of the issuer
· This money is sold or lent in exchange for other assets and generates revenue incomes to the issuer, and should so be reported in the issuer’s balance sheet
· These revenue incomes constitute a special form of rents, called seigniorage, which is are appropriated by the money issuer
· The accumulation (and non distribution) of revenue incomes thus generated constitute the equity of the issuer, and should be recorded as such in the issuer’s balance sheet
· This equity grants the holders of money ownership rights in the form of purchasing power over shares of the national wealth.
Two main implications follow.
First, rents from seigniorage are systematically concealed, and seigniorage revenue is not allocated to the income statement (where it naturally belongs) and is instead recorded on the liabilities side of the balance sheet, thus originating outright false accounting. Furthermore, primary seigniorage should be distinguished from “secondary” seigniorage, which derives from the interest income received on the money that is issued and lent out. The state does not receive any secondary seigniorage from coins (they are not lent), while central banks receive seigniorage from both banknote and reserve issuances but account only for the former and not for the latter.
Second, the same process that has led coins and then paper money and eventually central bank reserves to become legal tender partly extends as well to commercial bank money (i.e., sight deposits), which all of us use daily for transactions. In this case, although such money bears for the issuing banks the obligation to convert it into cash (on demand by depositors) or central bank reserves (for interbank settlements), its assimilation to legal tender grows to the extent that modern payment systems reduce the use of cash and economize on the use of central bank reserves.
An important (and still unrecognized) consequence of this assimilation is that banks’ deposit liabilities, recorded as banks’ ‘debts’ toward customers, generate revenues for the issuing banks – much as banknotes and reserves do for the central banks issuing them. Therefore, with reduction of cash usage and growing scale economies in the use of central bank reserves, increasing rents are appropriated by the (largely privately owned) commercial banking sectors of our economies.
The foregoing discussion offers a broad outline of a new approach that we refer to as the “Accounting View” of legal tender money. The proposed new approach calls for understanding money by correctly applying to it the principles of general accounting. We think it will be important to further deepen the study of the implications of the new approach.
From a very preliminary analysis, a most important one is the current under-appreciation of the seigniorage extracted by money issuers. It will be necessary to identify and to estimate such seigniorage, the share of seigniorage that is returned to its legitimate “owners” (i.e., the citizens), and its effects on economic activity, as well as on the economy’s incentives structure and the distribution of national wealth across the society.
With specific reference to public finances, we hope the new approach will eventually lead to “cleaning up” fiscal budgets and the balance sheet of central banks from the false accounting practices that derive from considering legal tender as “debt”. Finally, if money is accounted for as debt, instead of being considered as equity of the issuing entities and wealth for the society using it, it inevitably introduces a deflationary bias in the economy.
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 In fact, commercial bank money may serve as settlement instrument (and hence, de facto, as legal tender) for all interbank transactions taking place across accounts held on the books of the same bank (“on us” payments). Moreover, many payment systems adopt commercial bank liabilities as settlement assets (CPSS, 2003).
 ESA (cit.) establishes that "coins are issued by central governments in the euro area, although, by convention, they are treated as liabilities of the national central banks which as a counterpart hold a notional claim on general government” (emphasis added). The expression ‘by convention’ and the qualification of claims as ‘notional’, especially as they are used in a regulatory text, betray the lack of foundations supporting the concept of legal tender as a 'debt' liability of the issuing entity. We owe this observation to Marco Cattaneo.
 However, the similarity between money and goods in providing utility to holders and consumers, respectively, does not eliminate the unique features of money, such as its zero (or negligible) elasticity of production and its zero (or negligible) elasticity of substitution (Davidson, 1972).
 The very same real-time gross settlement (RTGS) systems, which typically require the mobilization of large volumes of central bank reserves, nowadays adopt technologies that permit the use of continuous (bilateral and/or multilateral) netting of interbank transactions, which drastically reduce the volume of reserves needed for settlement.
 That commercial banks create money (via their lending activity) is nowadays been recognized even by mainstream economic theory (McLeay et al., 2014). The secondary seigniorage that commercial banks extract from deposit creation derives from the revenue they receive from deposit issuances and the cost to raise the central bank reserves needed for settling payments (Bossone 2000, 2001 and 2017). It should be noted that in order for commercial banks to issue new deposits they do not need to incur new debts with customers (by accepting new deposits from them). They do need to raise the central bank reserves necessary to settle the obligations to other banks deriving from the holders of new deposits ordering payments. This can be achieved by mobilizing unutilized reserves, and accepting reserves from incoming payments, by borrowing reserves from the interbank market or the central bank, and by attracting reserves through new deposits (from old and/or new clients). The larger the share of the bank over total interbank payments, and the higher the efficiency of managing reserves for payment settlements, the less the reserves needed to support new deposit issuances,, and thus the larger the seigniorage. All else equal, commercial bank seigniorage increases when the central banks remunerates the reserves that commercial banks hold with it.