A couple of months ago a friend my sent me an article from the Guardian about how “Nazi Germany flooded Europe with fake British banknotes in an attempt to destroy confidence in the currency. The forgeries were so good that even German spymasters paid their agents in Britain with fake notes..The fake notes were first circulated in neutral Portugal and Spain with the double objective of raising money for the Nazi cause and creating a lack of confidence in the British currency.”
The article made me think about the impact of counterfeiting and whether thinking about the effects of counterfeiting could teach us anything about monetary theory. It should be stressed that my argument will not be a defense of counterfeiting. Counterfeiting is obviously fraudulent and as such immoral.
Thinking about the impact of counterfeiting we need to make two assumptions. First, are the counterfeited notes (and coins for the matter) “good” or not. Second what is the policy objective of the central bank – does the central bank have a nominal target or not.
Lets start out analyzing the case where the quality of the the counterfeited notes is so good that nobody will be able to distinguish them from the real thing and where the central bank has a clear and credible nominal target – for example a inflation target or a NGDP level target. In this case the counterfeiter basically is able to expand the money supply in a similar fashion as the central bank. Hence, effectively the nazi German counterfeiters in this scenario would be able to increase inflation and the level of NGDP in the UK in the same way as the Bank of England. However, if the BoE had been operating an inflation target then any increase in inflation (above the inflation target) due to an increase in the counterfeit money supply would have lead the BoE to reduce the official money supply. Furthermore, if the inflation target was credible an increase in inflation would be considered to be temporary by market participants and would lead to a drop in money velocity (this is the Chuck Norris effect).
Hence, under a credible inflation targeting regime an increase in the counterfeit money supply would automatically lead to a drop in the official money supply and/or a drop in money-velocity and as a consequence it would not lead to an increase in inflation. The same would go for any other nominal target.
In fact we can imagine a situation where the entire official UK money supply would have been replaced by “nazi notes” and the only thing the BoE was be doing was to provide a credible nominal anchor. This would in fact be complete monetary separation – between the different functions of money. On the one hand the Nazi counterfeiters would be supplying both the medium of exchange and a medium for store of value, while the BoE would be supplying a unit of account.
Therefore the paradoxical result is that as long as the central bank provides a credible nominal target the impact of counterfeiting will be limited in terms of the impact on the economy. There is, however, one crucial impact and that is the revenue from seigniorage from iss uing money would be captured by the counterfeiters rather than by the central bank. From a fiscal perspective this might or might not be important.
Could counterfeiting be useful?
This also leads us to what surely is a controversial conclusion that a central bank, which is faced with a situation where there is strong monetary deflation – for example in the US during the Great Depression – counterfeiting would actually be beneficial as it would increase the “effective” money supply and therefore help curb the deflationary pressures. In that regard it would be noted that this case only is relevant when the nominal target – for example a NGDP level target or lets say a 2% inflation target is not seen to be credible.
Therefore, if the nominal target is not credible and there is deflation we could argue that counterfeiting could be beneficial in terms of hitting the nominal target. Of course in a situation with high inflation and no credible nominal target counterfeiting surely would make the inflationary problems even worse. This would probably have been the case in the UK during WW2 – inflation was high and there was not a credible nominal target and as such had the nazi counterfeiting been “successful” then it surely would have had a serious a negative impact on the British economy in the form of potential hyperinflation.
Monetary separation could be desirable – at least in terms of thinking about money
The discussion above in my view illustrates that it is important in separating the different functions of money when we talk about monetary policy and the example with perfect counterfeiting under a credible nominal target shows that we can imagine a situation where the provision of the unit of accounting is produced by a (monopoly) central bank, but where production the medium of exchange and storage is privatized. This is at the core of what used to be know as New Monetary Economics (NME).
The best known NME style policy proposal is the little understood BFH system proposed by Leland Yeager and Robert Greenfield. What Yeager and Greenfield basically is suggesting is that the only task the central bank should provide is the provision media of accounting, while the other functions should be privatised – or should I say it should be left to “counterfeiters”.
While I am skeptical about the practically workings of the BFH system and certainly is not proposing to legalise counterfeiting one should acknowledge that the starting point for monetary policy most be to provide the medium account – or said in another way under a monopoly central bank the main task of the central bank is to provide a numéraire. NGDP level targeting of course is such numéraire.
A more radical solution could of course be to allow private issuance of money denominated in the official medium of account. This effectively would take away the need for a lender of last resort, but would not be a full Free Banking system as the central bank would still set the numéraire, which occasionally would necessitate that the central bank issued its own money or sucked up privated issued money to ensure the NGDP target (or any other nominal target). This is of course not completely different from what is already happening in the sense the private banks under the present system is able to create money – and one can argue that that is in fact what happened in the US during the Great Moderation.
Benjamin Cole
/ April 9, 2012Ah, counterfeiting, one of my favorite topics.
A book out recently, an the positive role played by counterfeiters:
http://www.nybooks.com/articles/archives/2011/nov/10/american-dream-money/
Essentially, I think if one can make perfect counterfeits, right now one would have a moral obligation to print as much as possible and go spend it. Or leave it on doorsteps, etc.
Lars Christensen
/ April 9, 2012Benjamin, thank you. I kind of expected that response from you to my post;-)
However, I am a bit puzzled by one thing and that is why you would find counterfeiting morally defendable, but still is skeptical about Free Banking.
Lars Christensen
/ April 9, 2012Btw Benjamin, have a look at Walter Block’s “Defending the Undefendable” Chapter 14: http://mises.org/books/defending.pdf
Bill Woolsey
/ April 9, 2012Even in the earliest versions of BFH, the checks or electronic equivalent were to be denominated in the official unit of account. In later versions, there was really no emphasis on mutual fund money, and instead a recognition that banks could and probably would issue deposits and banknotes denominated in the unit of account. But just as today, a one dollar deposit at Wells Fargo does not define the dollar, but is rather tied to the official dollar by redeemability, all of the actual money in a BFH system would be tied to the unit of account by redeemability–indirect redeemability. The “central bank” would not need to issue or absorb money, rather the rules for interbank clearings would get the banks to adjust the amount of money issued to maintain its value.
Benjamin Cole
/ April 9, 2012Lars-
I guess I need to study up a bit more.
My sentiment is that a sovereign central bank is a wonderful and powerful tool to have.
In hindsight we all talk about the USA housing bust. However, nationally in the USA, housing prices had not declined in generations (prior to 2007). Then that debt was securitized (MBS). That seems like a very safe investment–indeed, rated AAA.
There was a global glut of capital. caused by high savings rates. And high savings rates may not decline due to low interest rates–savers save for retirement, college, to buy a house or business, for economic security etc.
All of the above could have happened in free banking or fractionalized gold standard. Very strong and steady housing values, global glut of capital, securitized mortgages–indeed, free markets created all of that.
And we could have had the same collapse–and no central bank to print money and give it to banks.
So we would have had bank runs and a Great Depression that lasted for a couple of generations. I see no private-sector arrangement that could have withstood national bank runs, and remember, bank runs breed bank runs.
I believe in the sovereign nations, and central banks–at least until man devises a better way to secure human rights and contract law and commercial freedoms and accepted mediums of exchange.
No nation should ever give up the power to print money. In times of war (which I hope we never have) in times of Great Depressions, in times of turmoil, these powers give reassurance.
Without a printing plant, Greece is dead. Say goodbye to Greece for a few generations.
Sceptical
/ April 10, 2012B. Cole:
Your conviction that the bank runs have ended are premature and maybe a touch self-delusional. The banking system problems have not gone away, rather they have migrated to the core (sovereign and CB debt is now coming under pressure), as they always will in such a centralised, monopolistic system. In the case of a final failure, it will be the largest and most catastrophic, by definition since it is the center that will fail last.
In what way are central banks needed to “secure human rights and contract law and commercial freedoms”? The evidence seems to be gathering largely now that, in times of crises particularly, central banks will trammel all over such basics of civilised societies to protect the power centre of what is, in essence, now a broken insolvent system.
Frankly, your words sound like those of a money-printing madman from the Zimbabwe Mugabe regime, and many others going back through failed states. Playing God with the wealth of nations sounds good in the abstract but the destructive economic forces unleashed with such gross resource misallocations is well-documented. The inevitable obscene concentrations of wealth and power from such resource misallocations erode and ultimately destroy the will to produce, and the economic crises becomes political. It is not just a question of how much and how fast money is going around the circle but critically who has it, who controls the flows and is morally entitled to do so.
The monkeys eventually did throw the peanuts back out of the cage.
Benjamin Cole
/ April 10, 2012Sceptical–
I am keeping my peanuts.
How can a sovereign nation, with its own printing plant, default on debt? If it issues debt repayable in fiat currency, it can always pay off debt.
Yes, inflation will result, and a lot of inflation, if that power is misused.
A nation with a military can also misuse that military, with far, far worse consequences than mere inflation. However, we do not choose to demilitarize.
Greece is defaulting for exactly the reason I have stated: It has lost its sovereign right to print money. It is a perfect example of what not to do: Run fiscal deficits without the power to pay them off, either through taxes or printing. That leads to sovereign default, a terrible state of affairs.
Since it started its “austerity” programs, Greek debt has jumped from about 100 to 165 percent of GDP. Oh, great.
BTW, like most Market Monetarists, I am calling not for inflation, but a targeting of nominal GDP in the 7 percent range (now, for the USA, while we do own our own printing plant). At worst, that will result in 7 percent inflation, and we could hope for a 5 growth/2 inflation split in a better scenario.
He who trades economic prosperity for the security of price stability will soon find he has neither.
Benjamin Cole
/ April 11, 2012Spain has no ability to print money.
“Worst loss for Dow this year as stocks slump again
By CHRISTINA REXRODE, AP Business Writer – 1 hour ago
NEW YORK (AP) — The stock market suffered its worst loss of the year Tuesday because of uncertainty about coming corporate earnings reports and concerns that the borrowing costs of Spain are creeping close to a crisis level.”
–30–
What a mess. Without a central bank, Spain is like a one-winged bird. Sure, it should have a smaller public sector. Sure, it should balance its national budget–but balance while it has falling employment? Now?
I think the Eurozone is a failure. You cannot have a one-size-fits-all monetary policy.
really, should we have a global central bank? And since vast parts of the globe can grow at 7 percent a year, should we boost money supply by 7 percent a year. And what would happen in the USA if global money supply increased by that much?
Sceptical
/ April 15, 2012I think you are severly confused. On the one hand you say
“You cannot have a one-size-fits-all monetary policy” and in the same post advocate for central banking. Central banking is, by design, a one-size-fits-all monetary policy.
Grass roots, free market monetarism is the only way forward out of the monetary crises, such as Europeans are acutely experiencing now.
Money is, in essence, an information technology. It primarily functions to store and transfer value and pricing information. Distributed networks have proven themselves far superior over centralised systems, particualrly in robustness and scalabilty, for information technologies of the modern computing era. Monetary information technology networks will be no different. They will inevitably evolve from grass roots nodal solutions that scale to highly distributed, widespread networks. The regression theorem and network effects of money logically support this outcome also.
Supporting dinosaur inforamtion technologies like centralised banking is a losing proposition, in theory, from experience and on individual liberty. I hope you are prepared for that.