Notes and coins - the legal tender mind bender

The history of money is a long and winding road, with origins believed to be in credit, built on a foundation of trust. But the concept of money continues to be difficult to truly grasp, made paradoxically more difficult by our efforts to grasp it. Is money a piece of gold? A Yap stone? A promise? A dollar bill? A digital entry? When danger approaches and your fear compels you to hoard your money and hide - what are you hoarding, from who, and why?

The Bank of Canada describes money as unambiguously yet unspecific as one can - "anything can be used (as money) if the buyer and seller agree on the form of payment". But some players in the game are so powerful, and dare I say so trustworthy, that they can actually define the "official" money approved in their country for paying debts. That is - they define the country's legal tender.

In Canada, there are two such players, each with their own form of legal tender. Different issuers, different monetary aesthetic, different denominations. But both forms of legal tender are accepted by the state as payment, and are exchangeable at par.

Notes vs Coins

Notes are not the same as coins. While this may seem like a distinction without a difference, these two types of legal tender are vastly different in terms of how they operate behind the scenes.

The Bank of Canada issues bank notes. A lot of them. Almost $90B of them outstanding as of Q3 2019. As the Bank of Canada's most recent quarterly report describes - "the issuance of bank notes creates a liability for the Bank, the largest on its balance sheet". To offset this liability, the Bank "invests the proceeds from the issuance of notes primarily into Government of Canada securities, which are acquired on a non-competitive basis". This flavour of seigniorage is where the bulk of the Bank of Canada's revenue comes from - printing money, having financial institutions purchase that money (to fulfil customer demand), and then investing these proceeds in safe securities which earn interest. And these bank notes are accepted by (most) commercial institutions because we trust the Bank of Canada, and their notes are of such high quality that they are extremely difficult to counterfeit.

The Bank of Canada makes a point to articulate that it is separate from the political process - a special type of Crown Corporation, owned by the federal government, "but with considerable independence to carry out its responsibilities". And sensitivities around this independence have been felt since the Coyne affair of the early 1960s. The Bank's website further notes that "having an independent monetary institution allows for the separation of the power to spend money from the power to create money".

Imagine what life was like, then, before the Bank of Canada. The Government had the power to (and did) print, circulate, and spend its own currency. Ready to inflate at a moment's notice, destroying the economy in its wake. Well, it didn't really work that way (partly on account of legislation requiring additional note issuance to be backed by gold), so it's unclear that the creation of a central bank accomplished what legislation could not in this respect. And what's more - the Government is actually still (kind of) minting, circulating, and indirectly spending its own currency. In the form of coins.

The Coin Affair

The Royal Canadian Mint mints and distributes coins. A lot of them. While no overall outstanding value is published (that I can find), we can derive an approximate amount given the demand in 2018 for 415 million coins worth $132.4 million, and 3.239 billion coins in circulation (all values from the Mint's 2018 annual report). The total value of coins outstanding thus works out to a potential $1 billion, with seigniorage revenue equalling $95 million in 2018 (and seigniorage has been falling in recent years).

The Mint has a memorandum of understanding with the Department of Finance that "sets expectations" to provide Canadian circulation coins and coinage services to the Government of Canada. This effectively works by the Department of Finance purchasing the coins from the Mint for distribution, with the Mint paying a dividend to the Government annually for this privilege (i.e. the seigniorage revenue after accounting for production expenses, simplified greatly). So the Government effectively outsources the minting of its coins to the Mint.

This kind of feels like the same process as the Bank of Canada for printing notes, though dressed differently. The Bank of Canada is given the privilege (by the Government) of creating the country's bank notes, but rather than the Government paying the Bank for the notes like with coins, the Bank (as noted earlier) prints the bank notes, sells them to financial institutions, invests the proceeds in interest-generating securities, and returns the excess seigniorage revenue to the Government after paying its expenses (note that the Bank of Canada has several other functions that it also funds; I have also greatly simplified the accounting here for simplicity).

As an interesting thought experiment - imagine the Government deciding to follow the precedent of the one- and two-dollar bills, and 'coining' the remaining bank note denominations. This would have obvious implications for ATMs, and turn counterfeit printing on its head. But more importantly, it would raise questions about the future of the Bank of Canada's operations and balance sheet. Assuming the majority of bank notes would be returned by the public via financial institutions within let's say 20 years, the balance sheet would shrink substantially over this time. The Bank's revenue would subsequently decline materially, and its Currency function would cease to be a function, really. Questions would be raised as to how the Bank will be able to fund its own activities without a Government subsidy. Concerns over central bank independence would resurface. Call it the Coin Affair.

What is more likely, though, is that the fates of these two legal tenders will be decided by the most powerful group in the country. Not the Government, nor the Mint, nor the Bank of Canada, but by Canadians - and their demand for legal tender.