The New Money

By now you have probably received and spent some of the U.S. Treasury’s new currency. Starting with the hundred-dollar bill in 1996, the Treasury has redesigned all three of our larger denomination bills, and plans to redesign the smaller bills in the future. Treasury Secretary Robert Rubin, on release of the new twenty-dollar bill in 1998, said that each new bill “marks a new stage in the government’s assault on would-be counterfeiters.”

The new money certainly does contain an impressive array of features that seem to make it more difficult for anyone to produce a bill that would pass careful inspection: color-shifting ink; security threads; microprinting; fine line printing patterns; larger, more detailed portraits; and other security features designed to foil counterfeiters.

While the new currency is being put into circulation, the old will not be recalled. A reason, if not the reason, for not recalling the old currency is that so much of it is abroad. Upwards of two-thirds of all U.S. currency is held in foreign countries, and the Treasury feared disruption of those economies if the old money were declared to be invalid as of a certain date. So the old currency will continue in circulation alongside the new for years to come.

This has led some people to question whether the introduction of new bills will really do much to defeat counterfeiting. The old U.S. currency, according to experts, was among the easiest of all currencies to counterfeit. It had remained unchanged since 1929, giving counterfeiters a lot of time to hone their skills. Moreover, scanners and laser printers can do a very good job of reproducing the old bills. Other nations have updated their currency over the decades. The Australians, for example, produce their currency on plastic with clear windows, making counterfeiting difficult. But the old U.S. bills relied on what was the state of the art in 1929. So even if the new bills are hard to counterfeit, there currently isn’t any need to try.

Edward J. Green and Warren E. Weber, economists with the Federal Reserve Bank of Minneapolis, sought to evaluate the prospects for success of the Treasury’s policy of printing new bills, but honoring the old and only gradually removing them from circulation in “Will the New $100 Bill Decrease Counterfeiting?” (Federal Reserve Bank of Minneapolis Quarterly Review, Summer 1996). After a sophisticated analysis, they conclude that they can’t say: “Although we do not show that the current policy will necessarily be effective in the near term, we do show that a long-term failure cannot be taken for granted.” As federal programs go, that is actually not too bad.

A Question of Incentives

People, including government officials, generally act in accordance with their incentives. Where they stand to make a significant gain (or avert a significant loss) from taking action, they can be counted on to do so. As public choice economists have been saying for a long time, we should not expect that government officials will do things just because they are in “the public interest.” The interests of the state do not often coincide with the interests of the ordinary citizen. Counterfeiting is a species of fraud and should be illegal. But government officials devote their efforts and resources to fighting the crimes that do them the most good.

If violent crimes are on the increase, politicians take notice and will at least take some grandstanding measures so that opponents won’t accuse them of being “soft on crime.” If tax evasion is on the increase, politicians will really take notice, since tax evasion reduces their ability to spend money on the programs that voters like (or at least think they like). Counterfeiting, however, does not have much impact. Competition in the production of money is definitely not welcome, but if the unlucky citizen occasionally gets stuck with a bogus twenty-dollar bill, the loss is his. The political incentive to combat counterfeiting isn’t very strong compared to other goals and it should not surprise us that it has not been a high priority.

Furthermore, we may wonder if the attack on counterfeiting won’t turn out to be more a matter of bravado than of effect. Printing the new bills may deter some counterfeiters who conclude that it is too costly to produce new bills that will pass, but it is not going to keep creative people who want to augment their incomes from trying to make and pass bills. In fact, shortly after the introduction of the new twenty-dollar bill, I read an article in my local newspaper about an unsuccessful attempt to pass a very poor counterfeit bill. It was two sheets that had been copied and glued together—upside down! A store clerk easily identified the bill as a fake.

Store owners and everyone else taking money in exchange for valuable goods and services have a strong incentive to see to it that they are paid with genuine money (or checks or credit cards). They will take what they believe to be the optimal degree of precaution against accepting counterfeits, and if you observe the behavior of bank tellers, retail clerks, vendors, and others who handle a lot of money, you conclude that the optimal level of precaution is very low indeed. They rarely examine the money they receive with any care.

The new currency has features that make it possible for the average person to tell a real bill from a high-quality counterfeit with a good deal of certainty. Listen to Secretary Rubin: “If you tilt the note back and forth, you will see the color-shifting ink change from green to black, and back again. And by holding the note up to the light, you will see a watermark on the right, and a security thread on the far left with its own tiny lettering and graphics. These are simple things each and every one of us can and should do.” Sure, but how many money-handlers are going to take the time to look for those features unless a bill is printed badly enough to arouse suspicion?

Private Enterprise Versus Counterfeiting

The problem of counterfeiting is not unique to government currency. Businesses stand to lose money if people are able to counterfeit their products, and for that reason have a strong incentive to search for the most cost-effective means to prevent or detect counterfeits. Consider, for example, the credit card industry.

When bank credit cards were first introduced in the early 1970s, the issuers suffered large losses due to counterfeiting. It was easy for criminals to create and use phony plastic cards. The resulting losses were not diffused among the general public, but were felt by the card issuers, who realized that they had to find a solution.

The solution was the hologram. MasterCard pioneered the use of holograms in 1983 and since then they have become almost ubiquitous. Because hologram technology was not widely dispersed, this innovation dramatically reduced the amount of fraud through counterfeiting.

However, just as offense tends to catch up to defense and vice versa in war, eventually criminals found out how to produce them and get back into the card fraud game. But the card issuers, with a constant eye on the bottom line, continue to work to minimize losses. Some cards now bear a photo identification, and cardholders are also required to confirm receipt of new or replacement cards via telephone, which has proved effective in cutting down on theft.

Counterfeit software is also a financial problem for software makers. The new Windows 98 booklet has an elaborately printed certificate of authenticity and says in fine print: “IS IT GENUINE? If you believe this certificate or the software you obtained with your system is not legally licensed and/or may be counterfeit, please e-mail Microsoft at piracy@microsoft.com.” It is safe to conclude that Bill Gates has his executives constantly on the lookout for the most effective means of dealing with software counterfeiting.

Yes, credit cards, computer software, and many other items continue to be counterfeited, as does our money, old and new. The key difference is in the incentives of the people responsible. While business people who stand to lose money are always alert to the problem of counterfeiting and thus search for the optimal methods to deter it, government officials do not have such a direct, powerful incentive. After doing nothing innovative for decades, the Treasury has come up with an anti-counterfeiting program about which the best that can be said is, to repeat Green and Weber, “its failure cannot be taken for granted.”

Private Money?

Back in 1976, the Nobel laureate economist F. A. Hayek published a provocative essay entitled “The Denationalization of Money.” He argued that it was a grave mistake to allow governments a monopoly on money and that we should do away with legal tender laws and permit individuals to trade in whatever media of exchange they think best.

His reason for advocating this idea was not the problem of counterfeiting, but rather the problem of stability of value. Money issuers, private and governmental, would have a strong incentive to maintain the value of their money if they faced competition in the monetary marketplace. Depreciating money would be as undesirable as foodstuffs that rapidly rotted. Subjected to the test of the marketplace, good money would drive out bad money. (No, that is not contrary to Gresham’s Law, which says that artificially overvalued money tends to drive out of circulation artificially undervalued money; in a free monetary market, government cannot artificially overvalue anything.)

A good side effect of monetary competition, however, would be that it would also bring into play the market’s incentives to combat counterfeiting. Private issuers would compete in many respects, among them the reliability of their products. The firms that have already ventured into the realm of electronic money (e-cash) have taken pains to assure customers that accounts will be secure. Producers of tangible money would have the same strong incentive to see to it that their users had confidence in the genuineness and worth of their money.

We are used to thinking that the production of money is one of the core functions of government, but there is no reason why the production of money must be a governmental monopoly, or even a governmental function at all. There were private money producers—mints—in operation in America during the colonial period and also well into the nineteenth century. They had to pass the test of the market, unlike federal mints, and when they did so, they thrived. (For an interesting history, see Brian Summers, “Private Coinage in America,” The Freeman, July 1976.)

Marketplace competition provides the optimal incentives for maximizing consumer welfare—giving people the greatest value for their money. That applies to money itself. The next time you receive some money, new or old, you might think about that.