Seigniorage – the good old fashioned way!

When the Europeans published their upbeat retail sale report last week we asked a rather rhetorical question; where do you think all those ECB-money ends up?

Given Draghi`s broken monetary transmission mechanism is should come as no surprise that most of it ends up in the north.

As simple chart depicting a rebased retail sale series should help substantiate that claim!

     Retail Sales 2007 = 100 w Lux

Source: Eurostat, own calculations

In the new normal it pays to have a relatively large financial sector; unless you are Cyprus of course. More precisely; it pays to have a relatively large financial sector that caters to the elite!

And if it something tiny Luxembourg have an abundance of, it is financial service industries. The next chart breaks the Luxembourgian economy down to its components. As is obviously clear, the financial sector with its support functions have become a behemoth within a Leviathan.

The incredible growth of the financial sector has led to asset accumulation in excess of 8 times GDC! While this this is down from the heydays witnessed prior to the Lehman collapse, it is still among the worlds most bloated financial sectors.

Luxembourgian GDC

Source: Statec, European Central Bank (ECB), own calculations

Now, as we have shown extensively on these pages, the ECB is more or less designed to bail-out these too-big-to-fail institutions. However, there is one thing that we have until now neglected to mention, namely the issuance of banknotes; money printing in the literal sense of the word.

Within the euro system national central banks have been allocated a share of total currency outstanding as given by the “banknote allocation key” published by the ECB.

Out of the total, 8 per cent is a liability of the ECB itself, while the remaining 92 per cent outstanding is liabilities of the different national central banks.

For example, the National Bank of Greece has been allocated €22bn of the banknotes outstanding, while the mighty Deutsche Bundesbank has an allocation of €211bn, out of a total of €846bn.

However, the actual issuance does not necessarily correspond to the allocated amounts. If a national central bank has issued more than the allocated quota, it will accumulate a liability on its balance sheet called “Intra-euro system liability related to euro banknotes”. These liabilities will be counted against assets on central banks with issuance at quota or less.

At this point in our story we can almost feel the frustration and anger building inside our northern European readers. “Yet another way the euro system help siphon of my hard earned money to profligate southerners!

But that is NOT the case! Excessive note issuance is (almost) inversely related to sovereign bond yields! The deeper a country has sunk into the euro-quagmire, the less the NCB has resorted to excessive note issuance!

How come? We expect it to be demand driven and related to the deposit flight experienced by the southern European banking system.  As money moved from the south to the north demand for cash increased in the north!

Deposits flight

Source: European Central Bank (ECB), own calculations

That said, this can only explain why excessive note issuance has continued to grow in the period after 2008. But as the chart below show, note issuance above allocated quota has been going on since the start of the euro!

Germany has issued a whopping €211bn in excess of the allocated €210bn, or 100 per cent of quota. Still, no one beats Luxembourg! Our friends with financial acumen know the game of money printing better than anyone else. Per July 2013 the Banque central du Luxembourg reported more than €80bn in excessive note issuance, or 4,136 per cent above the stated quota of €1.9bn!


Issuance exceeding quota

Source: various national central banks, own calculations

Excessive issuance relative to quota

Source: various national central banks, own calculations


While many people, rightly so, focus a lot of attention on the TARGET2 bail-out, few adjust these numbers for the note issuance.

For example, the TARGET2 claim accumulated on the balance sheet of the Bundesbank has come down to €577bn from a peak of €751bn as a result of the OMT-promise. As the TARGET2 claim came down, note issuance kept rising so the net claim actually fell much more dramatically.

Bundesbank net claim

Source: Bundesbank, own calculations


All this make the euro-economy an oddity among peers. It is far more cash-based than, say the US and UK

Cash relative to GDC

Source: Eurostat, various NCBs, Bureau of Economic Analysis (BEA), Federal Reserve (Fed), Bank of England (BoE), Cabinet Office (CAO), Bank of Japan (BoJ), own calculations

Concluding remarks

The euro system has many peculiarities as we have shown extensively on our blog. To a large extent the system can be analyzed as a “tragedy of the commons” problem. As is well known in economics, when a shared resource can be exploited in full by individuals with no exclusive property right, the resource will be overexploited.

The euro is a shared resource. Every national central bank can exploit it to the fullest while the cost will be shared by every member state.

The incentive in such a system is obviously rigged to its disfavor and it will eventually break down.

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