Have you ever wondered how a government earns money, literally? One little-known but significant means is seigniorage—a word that might seem technical but has tangible impacts on your money and your investment decisions.
What is Seigniorage?
Seigniorage is the revenue earned by a government due to the production of currency. It's the amount between the face value of money and the money spent to produce it. For instance, if it costs Rs 3 to print a Rs 500 note, the government receives Rs 497 as seigniorage. It goes towards paying for government expenditures without raising taxes or borrowing more.
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But here's the thing: if a government prints too much money, it can cause inflation—where the value of money decreases, and prices of daily commodities increase. That slowly takes away your salary, savings, and investment purchasing power over time.
Why Should Investors Care?
Although the concept of seigniorage sounds out of an economics book, its impact exists subtly yet significantly in your life. When the government injects additional money into the financial system to meet its expenditures, and the economy is not expanding at a corresponding rate, it tends to cause inflation.
Fixed-Income Investors Take the First Hit
This affects fixed-income investments such as FDs, bonds, and savings accounts. These investments return you money at a fixed rate—but when inflation increases at a higher rate than your returns, the 'real' value of your money decreases.
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Suppose your FD returns you 6 per cent per year, but inflation is 7 per cent. You are essentially losing money. That is why knowing seigniorage helps you understand the bigger picture behind inflation trends.
"When a government uses seigniorage—the money it makes from issuing currency—to fund deficits excessively, it becomes problematic," says Anand K Rathi, co-founder, MIRA Money, an investment management platform. "Over-reliance on this instrument usually leads to inflation, which has an immediate effect on fixed-income investors."
"Since fixed-income products like government bonds, FDs, and pension instruments offer fixed payouts, their purchasing power erodes in inflationary environments created by unchecked money printing. For conservative or retired investors who depend on steady income streams, this is particularly worrisome," he adds.
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"Furthermore, sustained inflation brought on by seigniorage might also increase interest rate volatility, which would be detrimental to bond prices and the stability of the entire portfolio."
Real-World Examples: Zimbabwe and Venezuela
Two extreme illustrations of what can happen when seigniorage is excessively used are Zimbabwe and Venezuela. In both nations, the government printed cash to finance budget shortfalls and other expenditures, but their economies were not healthy enough to absorb the additional money.
The outcome? Hyperinflation. In Zimbabwe, the inflation rate doubled every few hours at its worst in 2008. People needed humongous amount of money to purchase even a loaf of bread. In Venezuela, the same was experienced with annual inflation reaching over 1,000,000 per cent for a while, eroding the purchasing power of people's income and savings.
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Though such events are unusual and extreme, they demonstrate the way excessive money printing without economic support can dissolve trust in a currency.
What Does Seigniorage Imply For You?
In India and in the majority of nations, seigniorage is used to a limited extent. But if you observe the government depending a lot on central bank funding (where the RBI lends directly or indirectly to government expenses), that's an indication of rising money supply.
As an investor, it's helpful to monitor not only inflation but also factors such as fiscal deficits, money supply growth, and central bank policy. These can provide early warning of how the economy is being handled and if inflation risks are building up.
Smart Investment Moves When Inflation Looms
If inflation is likely to rise, you might look to:
Invest more in assets that outperform inflation in the long term, such as equities or inflation-linked bonds.
Not locking money for long durations in low-yielding instruments.
Holding some part of the portfolio in hard assets such as gold.
"When building portfolios, investors must consider inflation risk and keep an eye on macroeconomic indicators including budget deficits, central bank monetisation, and CPI movements," says Rathi. "Short-term bonds and inflation-sensitive assets can be advantageous in these scenarios."
The Role of CBDCs
CBDCs (Central Bank Digital Currencies) could also fundamentally alter how seigniorage operates, Rathi notes. "With CBDCs, governments can issue digital currency at near-zero marginal cost, possibly increasing their ability to monetise debt directly and more rapidly. This could improve monetary efficiency, but also increases the risk of misuse."
"CBDCs may allow for more focused fiscal stimulus and faster monetary transmission; nevertheless, if exploited, they can exacerbate inflationary pressures," Rathi explains. "For investors, this implies more aggressive monetary policy and greater market volatility. It becomes critical to grasp macroeconomic policy direction and prepare portfolios for larger changes in purchasing power."
Additionally, Rathi points out that CBDCs may reduce reliance on traditional banks, which could change the situation for savers and fixed-income investors. "Overall, CBDCs facilitate seigniorage, both for good and potentially for excess."
Building a Shield
To protect against such scenarios, he recommends inflation-indexed bonds and gold. "India's CPI-linked bonds or US TIPS adjust payouts based on inflation, preserving real returns. Gold, though more volatile, tends to perform well when people fear monetary excess or geopolitical instability," says Rathi. "Together, these assets provide balance—bonds for income and protection, gold for systemic risk hedging."
Review Portfolio More Often
When asked, how often should investors review their portfolio, Rathi says, "In a stable environment, once or twice a year may be fine. But during visible signs of monetised deficits or rapid money supply growth, quarterly reviews are advisable. The goal is to stay ahead of macro trends."
"In such times, portfolio strategy should focus on capital preservation, liquidity, and protection of purchasing power. Avoid long-term debt and speculative equity bets. Keep an eye on fiscal deficit trends, monetary policy moves, and inflation data. Passive investing without attention to the environment can be a costly mistake," Rathi cautions.
Seigniorage might sound like it's just something that economists discuss, but its implications hit your wallet. Being aware of how governments generate money and how that activity affects inflation enables you to invest more intelligently. And, let's face it, being financially sound isn't solely about knowing where to put your money—but also about understanding what can creep into your returns unnoticed.
