Monday, April 21, 2008

Two Cents Worth

The value of the dollar has been falling and there have been numerous proposals to arrest the decline. The most obvious answer is to just stop printing so damn many of the things, but that's about as likely as finding an honest politician so I'm not holding my breath. Maybe a clue to how we can stop the devaluation of the dollar can be found in the lowly penny:

It costs money to make money. This fact is not only true for businessmen, investors, and entrepreneurs, but also for the moneymakers themselves — the Department of the Treasury.

To print bills or mint coins, the United States Mint and Bureau of Engraving and Printing must purchase all sorts of resources, including paper, ink, equipment, and metals. In the case of bills, these purchases are an insignificant fact because it takes very little to add on an extra zero to cover the costs.

Coins, however, are different. The price of the zinc required to mint pennies has been steadily increasing; according to a recent article in the New Yorker, the cost of producing a penny is now 1.7 cents — it costs nearly two pennies to make one. Producing a coin at a higher cost than the value of the coin itself is known as "negative seigniorage." This phenomenon has led many to question the continued existence of the penny and suggest it be abolished. Understanding negative seigniorage in economic terms will lead to an opposite conclusion: hundred dollar bills should be done away with.

The problem with paper currencies is that they are too cheap to produce. When you are in debt up to your eyeballs, as the US is, it is too tempting to just print up a few more and pay the bills. We need to make it more expensive to produce more money.

However, there does not have to be a hyperinflation for the effects of printing more money to be known. Any increase in the money supply, however minute, dilutes the purchasing power of existing dollars and thus throws off economic calculation. Curtailing the power of the government to print money means creating a more sound, prosperous economy.

How can this be achieved? Given that bills can be printed at an extremely high seigniorage, they do not offer a solution because the government will always be tempted to pay for its bloated expenditures with easy-to-print bills. What makes coins and other hard commodities desirable as currency is that they cannot simply be printed. Gold, copper, and silver must be dug out of the ground, so the government is limited in the amount that it can spend and, therefore, inflate.

Thus, the more expensive the penny — or any coin for that matter — the better. It is the paper that ought to be questioned. Does it make sense to give any institution in society the legal right to print money whenever it suits them? There can be no fiscal responsibility with a blank check.

Back in the early 2000s, the Fed was so worried about the potential for deflation that they flooded the economy with dollars. The result was a real estate bubble. What I have never been able to understand is why the Fed is so afraid of falling prices. Would you complain if the price of gasoline fell? The price of food? I think not. The Fed's fear of deflation is, of course, rooted in the Depression during which the US experienced a general deflation. It seems to me though that blaming the depression on deflation is to confuse cause and effect. Is it possible you could have deflation and not a depression? Is it possible to have a fever and yet not get the flu?

In a capitalist economy with sound money, prices should fall:

Government fiat does not raise the standard of living; production on the market does. In industries where there is innovation and more production, prices fall. This is best seen in the technology industry (not surprisingly, the sector of the economy with the least government regulation — contrasted with our interventionist health care system with its rising prices.) The reason prices are falling in technology is because the pace of innovation and production is faster than the pace of government-fueled inflation. Imagine if we had a stable currency and prices were able to reduce dramatically in all sectors of the economy.

The price of producing money should be expensive so that governments will be loath to produce too much. Abolish the dollar bill! Long live the penny!

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