Tuesday, December 13, 2011

A Question for Will Luther

Perhaps I'm overlooking something here, but I think Will can help me out.

I hear people mention that the price of producing a penny is greater than one cent. Moreover, the value of the materials used to make one penny are also greater than one cent. While I think there is something to the discrepancy between the two, I'm going to go with the latter-- the copper and zinc in a penny are worth more than one cent. And people use this as reason to get rid of the penny-- but I'm not quite certain where this eventually leads.

Free of government restriction, people would acquire these pennies, melt them down and use them for their material purpose. The money supply contracts, the copper and zinc supplies increase, and we end up at a new equilibrium. Fair enough.

But people aren't allowed to do that. It's illegal. I'm not saying that I agree with the law, but assume that people follow it and it remains in place for the indefinite future. Money system-wise, what's wrong with having a penny that's would be worth more than one cent in raw materials? What if pennies were made of gold-- what then? I suppose people could trade them as commodities expecting at some point to be able to use them as something other than pennies, but then we're back to the law and it either de jure or de facto not holding. The more valuable the penny, the stronger the incentive to get around the law-- but again, I'm curious what makes it not function as a unit of currency.

Does this penny-made-of-stuff-worth-more-than-one-cent argument necessarily need to go hand-in-hand with the ban on destroying money? If so, that's fine-- I just don't see people arguing it beyond "THE COPPER IN PENNIES IS WORTH TWO CENTS!" What am I missing here? I defer to Will's superior knowledge here and am eager to see where I've messed up.


Eli said...

I'm not Will Luther, but isn't the problem Gresham's Law? People would hoard gold pennies as a hedge against the monetary system.

Will Luther said...

"I hear people mention that the price of producing a penny is greater than one cent. Moreover, the value of the materials used to make one penny are also greater than one cent."

I understand the first to mean (materials + marginal production process) > 1 cent; the second that materials > 1 cent. The real economic question is (1) whether or not the penny is sufficiently useful to warrant its existence (perhaps not in the way it is currently made; possibly if cheaper materials were employed) and, if so, (2) whether the marginal penny is sufficiently useful to warrant its existence (in other words, how many pennies should be in circulation). Given that there are many ways one might make a penny, the answer is not obvious.

You are more or less on the money, Matt (pun intended). Eli is also correct to point to Gresham's law. If the penny is over valued (exchange value > cost), forgery is encouraged. If the penny is under valued (exchange value < cost), it pays to repurpose existing pennies. (For example, you will occasionally find pennies with holes drilled in them functioning as washers because the penny + wear and tear on your drill press + (prob of getting caught)(punishment) was cheaper then making the trek to the hardware store to make a legal purchase.)

With fiat monies, overvaluation is more common. A $100 costs about 6 cents to make. Maintaining overvaluation requires monopoly privilege (I'll be linking to my newest paper on Somalia soon!). Outside of hyperinflation, undervaluation is pretty rare---which is why the penny is often talked about. In the same way that maintaining overvalued fiat monies requires monopoly privilege, maintaining undervalued fiat monies require the prohibition of repurposing. Network effects and transaction costs might mean it is not a knife-edge equilibrium, but you get the point.

Matt E. Ryan said...

Will Luther: He knows about money.

Henceforth, I'll play the surly internet bully and demand people supplement their penny/copper/zinc comments with the appropriate back story.