18 July 2016

The Economics of Counterfeit Money




July 14th, 2016 
by Philip Pilkington
Endogenous money theory, which is usually associated with the Post-Keynesian school of economics, has long told us that central banks do not control the supply of money in the economy. Instead the amount of money is determined by the demand for money which, in turn, is determined by the demand for credit. This idea, however, leaves out what is actually a rather important component: counterfeiting.
Follow up:

Of course, endogenous money theory is not at odds with the counterfeiting of money — after all, why would anyone counterfeit if it were not for their demand for money — but it is rarely discussed. I assume that the reason for this is that endogenous money theorists think that it is a small-scale phenomenon. But this is simply not the case; when one looks into it, it is actually extremely widespread. In Britain, for example, some 1% of banknotes are counterfeit, while one in thirty-three pound coins are fakes.
That is an enormous number, so why aren’t economists more aware of this? Well, it would seem that the central banks don’t want to be too vocal about this because, frankly, it undermines some of their perceived powers. The Independent says,
The Bank of England plays down the gravity of the situation. “It’s not serious,” said a spokesman. “Less than l per cent of the pounds 18bn of genuine money in circulation is fake.”

But those who run businesses disagree,
John Hall, head of security at the 1,700-strong Co-Operative Wholesale Society chain, reckons it is getting worse: “Over the last year, counterfeit money through our stores has jumped 20 per cent,” he said. “The quality of the forgeries has improved enormously and the counterfeiters have switched from photo-copying to computer-generated graphics, which give a cleaner image and are more difficult to detect.”
Clearly the Bank of England are trying to play down the problem. I would argue that this is not just because it undermines their perceived autonomy in controlling the money supply but also because, if examined carefully, money counterfeiting is actually in agreement with the Bank’s present policy goals.
One of the aims of the Quantitative Easing programs was to fill private banks with reserves so that they would loan them out and increase the quantity of money in circulation. This did not occur, but where the QE program fails, counterfeit money succeeds. There is no doubt that every time a £20 note is counterfeited it circulates in an identical manner to a real one, generating incomes and profits, until it is discovered and removed from circulation. In a time where even the central banks recognise that there is a major output-gap money counterfeiting actually goes some way to filling this.

So, what is the magnitude of this hidden stimulus? Well, in 2009 it is estimated that cash transactions totaled £266bn. In the same year, nominal GDP — that is GDP in nominal money terms — was estimated to be £1.417trn by the OECD. That means that about 19% of nominal GDP in 2009 was made up of cash payments. If we assume that 1% of these cash payments are counterfeit then about 0.19% of total nominal GDP is being driven by counterfeit payments in the UK.
In a world where every tenth of a percent of GDP growth matters, this is a not insignificant number. No wonder then, that economists at the Bank of England are so reticent to discuss the phenomenon of money counterfeiting in any detail.

Of course, I am not endorsing the counterfeiting of money. It obviously redistributes incomes to criminals. Nevertheless, one simply cannot deny that in an economy that is not operating at full capacity money counterfeiting adds to incomes.

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