Gresham’s Law and the Indian Coin Shortage

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Gresham’s Law is popularly known as, “Bad money drives out good money”. In effect, people will hoard valuable money but will spend (and thus get rid of) money that is relatively more worthless.

The case in point that JMR Ben thoughtfully provided was a link to the news.bbc.co.uk report titled “Sharp Practice of Melting Coins“. It seems that inflation in prices in India (due to the Indian central bank creating so damned much money and credit every freaking day, just like all the other stupid central banks of the stupid world) has made the rupee almost valueless, but the little bit of metal in the coins is so valuable that “Millions of Indian coins are being smuggled into neighbouring Bangladesh and turned into razor blades”.

How much more valuable is the metal in the coin? The conversion ratio is a one-rupee coin can be made into seven razor blades, worth 35 rupees!

The natural result of Gresham’s law in action is “an acute shortage of coins in many parts of India”.

Naturally, coping mechanisms spring up, such as, “Shopkeepers ask customers to buy more to make it a round figure so that small change does not have to be given out”, shopkeepers giving “toffees or cigarettes to make it a round figure” and even issuing cardboard scrip.

The most surprising, astonishing and terrifying thing was the actual, in-your-face admission of further government debasement of the money! My eyes pop from my head in disbelief as I read that “The mints took corrective action – scaling down the metal content of the coins – but that has not stopped the shortages”.

If the Indian mints wanted to take “corrective action” against the inflation that is rendering the coins worthless as money, they would storm the central bank of India and stop them from creating so much money and credit!

And it is not just Indians, but according to a fax of a Globe and Mail article from Junior Mogambo Ranger (JMR) Andrew G., inflation in Canada is making them think of ditching the penny. The metal in the Canadian penny is worth so much more than the one-cent face value of the coin that pennies are, just like in India, being hoarded. To make up the shortfall, the Royal Canadian Mint was forced to increase production of pennies to 1.4 billion last year, enough pennies to represent “63 percent of total circulating coin production”.

This phenomenon of disappearing coins must be happening almost everywhere, too, as all currencies are being debased by their central banks, and coins with a low, fixed denomination on them are doomed as the buying power of the coin falls below the melt value of the metal in the coins.

And sure enough, the article notes that “Australia [stopped] making one-and two-cent coins in 1990. New Zealand stopped making them three years before that. France, Norway and Britain are among the other countries that have eliminated low-denomination coins.”

So inflation is hitting everywhere, literally rendering money increasingly valueless, and yet the governments allow the banks to just keep printing more and more of it! This is insane!

Bill Bonner of the Daily Reckoning doesn’t want to talk about what or who (looking directly at me) is insane or not, but astutely notes that “if you could really get rich by printing more currency, Zimbabweans would all be as rich as Midas, since the Mugabe government runs the presses night and day”.

And to underscore this point, Junior Mogambo Ranger (JMR) Phil S. forwarded the latest Cathy Buckle letters from Zimbabwe. She lives there, coping with the highest inflation (over 5,000% at last estimate) in the world, the most stupid, corrupt and demonic government in the world and prices which are now (according to Ms Buckle) “going up by an estimated 10 percent every day”.

But Ms Buckle does not want to be drawn into a boring discussion with The Mogambo about inflation in the theoretical abstract. She sticks to the horrific specifics and says, “Because of the oppressive, iron-fist regulations from Harare, individuals are only allowed to withdraw one and a half million dollars at a time from the bank – even if they have just deposited a hundred times that amount the same day. The bank charges a ‘handling fee’ for the withdrawal of amounts of one and a half million dollars or less, but you cannot withdraw more without applying for permission from the Reserve Bank in Harare.”

Aside from the fact that the Zimbabwe dollar and the US dollar were on a rough parity a decade or so ago, “To put all these figures in perspective,” she explains, “you have to stand in a queue in the bank for four days in a row – each day drawing out the maximum amount, each day paying the ‘handling fee’ – in order to purchase one tank of fuel for your car”. One tank of gas!

And if you want to hear some good news of belated smarts as pertains to money and how fiat money in the hands of an irresponsible government always becomes worthless, Julian D.W. Phillips in The Gold Forecaster newsletter notes that “Italy has no plans to sell any gold, which is unsurprising given the very poor history of the Italian lira. They too have seen several currencies come and go in the last one hundred years, so they have few illusions about the joys of compound interest. After all, adding noughts to a currency doesn’t make them more valuable; it’s the buying power that counts.”

Until next week,

The Mogambo Guru
for The Daily Reckoning Australia

Mogambo Guru
Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.
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Comments

  1. New Zealand withdrew their 5c coin this year. The smallest coin is now 10c.

    Warrick Nelson
    July 10, 2007
    Reply
  2. In the US, the expanded money supply has been almost completely limited to the amounts of credit created by banks and other lending agencies. The proportion of real currency has been dropping for decades, and its absolute amount has also been stagnant for the last few years.

    What this means is, that the ongoing inflationary trend is not “real”. It could suddenly reverse itself into a very aggressive deflation. If the cycle of credit is broken, the credit-based part of the money supply could contract very suddenly.

    A large amount of defaults can propagate upwards in the chain of lending, decimating the bank accounts of each link without actually reducing a single dollar from the monetary base. We could be witnessing the first steps in such a collapse right now. First it’s the home owners, then the hedge funds that own Mortgage Based Securities, then the banks that provide the leverage to those hedge funds.

    One can think of it this way: The total amount of US currency in circulation is about the same as the current account deficit (ca. $800 bn). If foreigners stop lending their dollars back to the US economy and start to hold them as cash, they could very soon cause an actual shortage of cash in the US. Holding dollars in cash would suddenly be a very tempting idea, if a massive deflationary trend would show up. This could be started by the ongoing housing deflation. A deflation expectation would make people even more prone to holding cash, and the cycle would rapidly accelerate out of control.

    If the FED responds to this by rapidly printing more cash, an even greater inflationary wave of liquidity would follow when the credit starts to expand again.

    The markets are also full of derivatives that are supposed to handle all risks. What happens if major sellers of credit derivatives start to default on their obligations? Does anybody control the amount of risk that these companies can buy? What happens, when investors have sold their credit risks to a company that has bought more than it can deliver?

    The current proportion of credit to currencies worldwide is very high. This means, that the money supply is not stable. All central banks should start to work towards a steady correction to the excess amounts of credit worldwide, perhaps by steadily increasing the reserve requirement ratios. If credit is allowed to grow without limits, it could suddenly explode by itself, bring ing the whole worldwide banking industry to a collapse.

    Reino Ruusu
    July 30, 2007
    Reply

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