Understanding dollar bills: Is this guy destroying wealth?

In: Blog

13 Apr 2012

Does shredding dollar bills destroy wealth?

This question offers an opportunity to ascertain to what extent money (in the form of dollar bills) does, or does not, embody wealth.


Ok, so does the picture above illustrate an act of destruction of wealth?

Well, it certainly does not portray an act of destruction of our capacity to produce real wealth.

Why not? Isn’t this guy, depending on the scale of the operation, harming the wealth of the nation?

Surely not! This guy’s action does not affect his (or our) ability to work, plan, produce, project, or innovate. It does not make our human (physical, or social) capital any poorer.

Does this mean that destroying dollar bills like this guy does is of no consequence?

It all boils down to who this guy is.

What difference does it make?

Suppose the unknown guy pictured above is a wealthy, lunatic chap who decided to kill time with some funny game that costs him 20 dollars every, say, 5 seconds (the time needed for each note to get shredded). Irrespectively whether he does it for fun or otherwise (as a political gesture to show distrust in the U.S. government, or God knows what), he is surely destroying his own financial wealth, wiping out some of his power to pay outstanding liabilities as well as to pay for some real good or service he might enjoy consuming. When cash is shredded, he has less purchasing power. So, he had better stopped before he loses all his cash and is forced to sell a property to meet his April deadline to pay his income taxes!

Who else could this guy be?

Suppose the guy works for the Federal Reserve Bank System, and the dollar bills are owned by the Fed. Then there is no destruction of any wealth, real or financial, at all.

What does this mean? Does the Fed overtly destroy our money?

No, of course not. The money being inserted into the shredder by a guy working for the Fed is not “ours”. It is dollar bills that have been withdrawn from circulation and the Fed destroys them because they are no longer usable. They usually package the shredded pieces to make nice souvenirs for visitors of the Fed.

And isn’t the Fed destroying wealth in the process? And don’t they need to offset this somehow?

When the Fed shreds dollar bills, it does not destroy wealth in any form. And the Fed may or may not replace the dollar notes withdrawn from circulation with newly printed ones, depending on our needs, and on crime.

How does crime fit into this?

If there were less crime, people would likely use less cash, and the Fed would withdraw dollar notes from circulation more than it prints and issues as new.

Then, why there is no destruction of financial wealth if the guy works for the U.S. Fed?

Just think of a dollar note as an IOU, issued by the central bank, acting on behalf of the national state. Any IOU that I know of only has value as long as it is held by a party different from its issuer. This is because the party holding it can claim its value with the issuer. The last time I issued an IOU to one of my sons, he knew he could claim cash from me. When I paid my debt, he swapped my IOU with an IOU of the Fed. And when I received my signed IOU back, I tore that piece of paper into pieces, just like the Fed does here.

If dollar bills are IOUs, what is it that we can claim by presenting dollar bills?

Tax credit. If we have a tax liability we can zero it by delivering an equivalent amount of cash to the U.S. Treasury. Once cash (assuming one pays taxes in cash) has returned to its issuer, it could be stored for future use, or (most likely) tore or shredded, just like this picture shows, to be replaced with freshly printed dollar bills, if needed.

But isn’t the Fed the issuer, and isn’t the Treasury a different body?

Yes. This is a very good point. Indeed, the Treasury will not destroy cash before it keeps score of the fact that a certain amount of taxes has been paid. It will thus change the numbers in the account that the Treasury holds at the Fed. Once the Treasury and the Fed have kept due record of tax liabilities paid, and assuming they wish to keep the dollar bills in circulation in good shape, they’ll go ahead and destroy worn banknotes. Paying taxes is a spreadsheet operation.

Is the printing of dollar bills a cost to society?

This is another good point. First, consider that the expenses incurred for printing dollars create incomes for capital and labor used in the process. There is a real cost to society only if, should the printing of banknotes stop, capital and labor were immediately employed to produce something else. In any event, the private sector maintains a desire for holding cash, and it seems that society attaches value to the quality of banknotes in circulation. So, printing banknotes and replacing those worn seems to be a socially valued activity.

One last point: Isn’t the printing of banknotes a terrific deal for governments? Isn’t this a source of what is called “seigniorage”?

“Seigniorage” is a medieval word indicating the difference between the face value of a coin and the cost of producing it born by the coin issuer. This was the rent that the government could extract from issuing coins by being the monopolist of coins. With paper money the notion is the same, but it is inapplicable to the contemporary world.

Why?

Today, “seigniorage” earned by the U.S. Fed originates from the difference between the yields it obtains from holding assets (including loans to banks) and operating costs. Printing banknotes is more of a nuisance than a boon. When the Fed ships dollar bills to a bank, it simply swaps an electronic IOU with a paper-based IOU. And the Fed can “print” money more cheaply by simply crediting the account that the banks have at the Fed (as opposed to printing dollar bills). Printing banknotes is more expensive than changing numbers on a computer.

Is a cashless society possible?

It is possible, yet unlikely. People demand the possibility of making payments anonymously, and this is only guaranteed by cash in its current form.

1 Response to Understanding dollar bills: Is this guy destroying wealth?

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warren mosler

April 13th, 2012 at 16:13

more cash in circulation means fewer balances in Fed reserve accounts, and since the Fed pays interest on reserve balances, more cash in circulation means lower government interest payments.

And for a given size of government, that means taxes can be lower to offset the effect of the reduced payment of interest.

So, bottom line, those holding currency earn less interest than if they had those funds on deposit, while taxpayers benefit.

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