Monday, July 24, 2006

Seigniorage

Macroeconomists are often troubled by the inability of central banks to avoid the temptation that printing and issuing paper money offers in the way of seigniorage, the "earnings" a government gets by printing, say a $100 bill for a cost of 50 cents and then spending the $100. The major problem, of course, is that this can lead to rampant inflation, as time-inconsistent governments print money to earn seigniorage, thus raising inflation and inflation expectations. Thus, in the future the government must print even more money and keep inflation growing faster to keep earning seigniorage. This cycle can lead to tremenous inflation episodes, such as the current situation in Zimbabwe.

But what happens if you could print money without harming the value of your currency? Seems great, no? But how would one do that?

An article in the NY Times Sunday Magazine yesterday suggests a way to do it: counterfeit someone else's currency. The article focuses on evidence that North Korea has been printing *lots* of counterfeit U.S. currency over the past several years. Apparently, the Secret Service has removed $50 million worth of "supernotes," the term for the nearly flawless counterfeits in question, from circulation. (And presumably, there are plenty of notes out there that have not been confiscated.) These supernotes are printed using intaglio printing, a method of printing which is generally only used by governments to print money, using specialized presses that are generally only available to governments.

The article suggests that U.S. government officials are taking the issue very seriously, and some senior members suggest that at times throughout history, counterfeiting by a foreign government has been seen as an “act of war" and that "the counterfeiting could be construed by some as a hostile act against another nation under international law and added that the counterfeits, by creating mistrust in the American currency, posed a `threat to the American people.'"

Although it seems unlikely to me that North Korea (or anyone else) would be able to circulate enough counterfeit money to really have an impact on the money supply in the U.S., this does strike me as a very serious problem. Is it an act of war? At first glance, that seems like a stretch, and I certainly don't think that military action would be an appropriate response to something like this. But it has the potential, if ramped up to a large enough degree, to have very serious consequences.

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