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I'm curious whether one can numerically calculate the effect that counterfeiting has on an economy.

As I understand it, counterfeiting essentially amounts to theft of the wealth of everybody holding units of that currency. For example, say you have an economy with 100 units of currency currently circulating. Bob creates 100 fake units of currency. If he does nothing but leave them in his safe, then the economy is unaffected. However, if he spends all of them, he will get goods and services in exchange for nothing of value. This is the theft. Him introducing his 100 fake units into the economy doubles the money supply, which will eventually more or less lead to a doubling in the price of everything (but not necessarily).

So now, if Dave had 10 units of currency his purchasing power was X. However, after the counterfeiting and doubling of the money supply and thus more or less doubling of prices, his purchasing power is X/2. Likewise for anybody who was holding that currency.

So, is it correct to say that in an economy with X currency units, counterfeiting and spending Y fake units is equal to theft of Y/(X+Y) of the wealth of the economy?

e.g. Given 100 legit units and counterfeiting and spending 200 units, 2/3rds of the wealth was stolen?

If not then what is the effect?

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  • $\begingroup$ All these wonderful answers and yet I find it fascinating that the counterfeiter and the institution creating money unsecured by assets or income have identical outcomes: money created out of thin air. $\endgroup$ – Daniel Mar 26 at 5:37
  • $\begingroup$ An excellent follow up question to this post would be: how is writing a derivative based on false claims of asset valuation any different from counterfeiting? $\endgroup$ – Daniel Mar 26 at 5:38
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So, is it correct to say that in an economy with X currency units, counterfeiting and spending Y fake units is equal to theft of Y/(X+Y) of the wealth of the economy?

(Emphasis added.)

No. It is correct to say that spending Y fake units is equal to the theft of Y/(X+Y) of the money holdings of the economy, which is not at all the same thing.

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  • $\begingroup$ Can you elaborate: why not? And what would it be correct to say then? $\endgroup$ – Claudiu Dec 11 '14 at 2:33
  • $\begingroup$ The total value of everyone's currency is not the same as the total wealth of the economy for exactly the same reason that the total value of everyone's refrigerators is not the same as the total wealth of the economy. And I already told you what it would be correct to say. $\endgroup$ – Steven Landsburg Dec 11 '14 at 2:34
  • $\begingroup$ Oh my mistake, I read it as "No. It is not correct to say..." and then that you repeated what I wrote. I didn't read carefully. $\endgroup$ – Claudiu Dec 11 '14 at 3:01
  • $\begingroup$ @Claudiu: No problem. I hope it's clear now. $\endgroup$ – Steven Landsburg Dec 11 '14 at 3:25
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    $\begingroup$ @Claudiu: I've added some boldface to stress the difference so that others don't fall into the same trap. $\endgroup$ – Steven Landsburg Dec 11 '14 at 3:26
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I'm adding this as a separate answer because it's quite independent of my other answer.

We've agreed that if there are X dollars existing and you counterfeit Y dollars, then you've stolen Y/(X+Y) of the value of those X dollars.

This assumes you do your counterfeiting all at once, and without warning.

If instead you do your counterfeiting slowly over time, or if it can be anticipated, then there's an additional effect: people try to rid themselves of money holdings in order to avoid being stolen from. (That is, they try to trade dollars for goods before the dollars lose value.)

This is costly to the moneyholders, with no offsetting benefit to anyone. One way to see that it's costly to moneyholders is that they now own less money, which makes their lives less convenient. A different way to see that it's costly to the moneyholders is that the rush to trade money for goods bids up prices, which lowers the value of money. (These are not two different costs; they are two different ways to think about the same cost.)

So in this case, you have stolen more than Y/(X+Y) of the value of originally existing money, but kept somewhat less (because by the time you get to spend your dollars, they're worth less than dollars were worth at the outset). The difference between what you steal and what you keep simply dissipates.

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I think the answer should be more complicated, and this won't be a complete answer at all.

You are assuming that counterfeit money is forever passed along? Counterfeit money is eventually taken out of circulation, so prices shouldn't move as perfectly as you suggest. But, given this fact, we might want to think about the costs of forcing counterfeit bills out of circulation.

I will direct you to this selection from the introductory paragraph of this paper by L. Smith and E. Quercioli which models counterfeiting as a game. The Economics of Counterfeiting. Smith's site says it is conditionally accepted at Econometrica. They also discuss data on pass rates.

The domestic losses from check fraud may well have exceeded \$20 billion in 2003 (1). Counterfeit money is much less common but still costly: The counterfeiting rate of the U.S. dollar is about one per 10,000 notes, with the domestic public losing \$80 million in 2011, more than doubling since 2003. The indirect counterfeiting costs for money are much greater, forcing a U.S. currency re-design every 7–10 years. As well, many costs are borne by the public checking the authenticity of their money (2).

Footnotes add

1Data here is sketchy. This estimate owes to a widely-cited Nilson Report (www.nilsonreport.com). 2Arguably, the \$500M budget of the Bureau of Printing and Engraving, and maybe $1B of the Secret Service and Treasury budgets owe to anti-counterfeiting. Also, there is a large private sector industry.

Given how new this paper is, I would take that as an indication that there aren't terrific estimates to measure the losses. Perhaps this owes more to data than theory. Still, you could also cook up strange models where counterfeiting alleviates money shortages, making it a good thing (e.g. everything is fiat so why not just pretend the counterfeit stuff is good too?). But that seems implausible.

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  • $\begingroup$ For the purposes of this exercise let's assume the counterfeit is indistinguishable from the real stuff. Like say you manage to perfectly duplicate the plates that create $100 bills. $\endgroup$ – Claudiu Dec 10 '14 at 20:06
  • $\begingroup$ Okay in this case you can re-optimize to avoid the severe losses you describe. Landsburg explains this in his second answer. Money becomes less valuable as because of inflation. This might actually be best modeled in a "money search" model. $\endgroup$ – Pburg Dec 11 '14 at 4:33

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