Preventing the flight of pennies with armed border guards

Posted by Marc Hodak on July 14, 2007 under Unintended consequences | Read the First Comment

For most of our history, the U.S. penny was made mainly of bronze, which is 95 percent copper and 5 percent zinc and tin. As the penny’s value deflated over time, it’s constituent metals became worth more than one cent. In 1962, the tin content of pennies was removed to increase their melting point. By 1982, when the copper value of pennies became sufficiently worth more than a cent that pennies were again in danger of getting melted for their intrinsic value, the mint re-designed the penny to become a copper-coated zinc coin–97.5 percent zinc and 2.5% copper. Last year, even that mineral content was no longer cheap enough. The cost of minting a penny was about 1.23 cents, and once again an arbitrage opportunity for coins appeared.

Like all organizations involved in making things, government’s have various tools at their disposal, such as mineralogy and production efficiencies, with which to react to the arbitrage opportunities they sometimes create. But when all else fails, governments have a tool that no other organizations possess–a monopoly on violence. So, last December, the U.S. government instituted fines and jail time for anyone melting coins for their mineral value.

How effective are such government interventions? I guess it depends on how you define “effective.”

The cost of enforcing relatively unenforceable rules can get very high. So can the economic loss in which the government is engaged that creates an opportunity cost for others, like spending 1.23 cents to produce a one-cent coin (times 8.7 billion coins per year). There’s also the opportunity cost of the lives of entrepreneurial people behind bars making license plates instead of correcting a market imperfection created by the government.

Opportunity costs are so hard to visualize, though, so it’s worth finding a more visible example of where these things lead. In India, where the steel in their rupees can be sold for up to 35 times that amount, India’s has deployed a paramilitary force along their border with Bangladesh to prevent coin smuggling. Like most governments, India also makes it illegal to introduce substitute currency. Tea gardens in Northern India have made rupees from cardboard slips for use in their establishments.

“We will commit an offence if these cardboard slips go out, but we have to use them in our gardens because there are hardly any Indian coins in circulation here,” said a manager of a tea garden. He is not willing to be named because the disclosure could cause legal complications for the estate.

By making substitute currency illegal, and having their legal currency worth less than its face value, many Indians are now spending their productive hours doing interesting things.

In Calcutta alone, India’s central bank – the Reserve Bank of India – has distributed coins worth nearly six million rupees ($150,000) to overcome the shortage in the last two weeks, bank treasurer Nilanjan Saha said.

Long queues form outside the bank’s regional office in the city centre every time this happens.

Unscrupulous touts set up makeshift shops and collect as many of the coins as they can, only to sell them later at a premium.

“We stand in long queues but the coins are finished within no time. Those in front pick them up and we can see some of them later selling the coins at a big margin,” complained small trader Nitai Banik, who needs a lot of coins for his retail trade in small garments.

Interestingly, the only actor in this scene doing economically productive work, the arbitraging touts, are tagged by the author as “unscrupulous.” The next step for the government, of course, is to crack down on these touts, which would not help the situation.

Alas, even in purely financial endeavors, governments consistently demonstrate the limit of both their economic literacy and their operational imagination.