Ripping up money to make money worth more?

August 14, 2007 10:39 AM

Why would ripping up money make money more valuable? Would it?

The question comes from an article about giving money to the homeless, and it is to be found here: the Freakonomics blog @ NYT.

"A third option, only implied in the question, is to simply rip up the money. This will make the currency of others worth proportionately more and spread the gains very broadly. Since many dollar bills are held by poor foreigners (most of all in Latin America), the gains would go to those who are able to save in terms of dollars. This would include many hard-working poor people, a group I regard as worthy recipients."

The obvious answer is "because there's less of it, it's worth more" but if I were to stage a stunt like burning £1,000,000 and didn't tell anyone, how would money become worth more? Please elaborate on how this all works.

posted by takeyourmedicine to work & money (20 comments total)

Increased scarcity implies increased value
posted by dmt at 10:41 AM on August 14, 2007

This is one of those economics puzzles that works best if all the economics assumptions are in place, including prefect information in the market.
posted by The World Famous at 10:42 AM on August 14, 2007 [1 favorite]

Perfect, that is. Not prefect.
posted by The World Famous at 10:42 AM on August 14, 2007

It's like if you have four children in your will, and then you disown one, and the other children get more.
posted by smackfu at 10:49 AM on August 14, 2007 [1 favorite]

but if I were to stage a stunt like burning £1,000,000 and didn't tell anyone, how would money become worth more?

Did you happen to notice an increase in the value of the cash in your pocket on or about August 23, 1994?
posted by googly at 11:00 AM on August 14, 2007 [1 favorite]

In the linked blog post, the question revolves around what to do with $10 to assist the homeless, and one respondent mentions the rip-it-up option. In the paragraph after the one quoted, he pretty much rejects that idea.

Now, when a central bank just prints money and puts it into circulation, that causes inflation and makes all the currency have less value. So conversely, taking money out of circulation theoretically increases the value of the rest. But burning $10 or £1,000,000 is such a small drop in the bucket it won't have any effect at all. Removing a huge amount of money from circulation would potentially cause deflation (money increases in value, prices of goods and services fall). However, deflation is potentially more devastating than inflation (the Great Depression was a deflationary spiral, which is hard to stop -- lower prices lead to lower wages, lower wages lead to lower prices, etc.), so central banks are careful to aim for low inflation, not a zero balance between inflation and deflation.
posted by beagle at 11:05 AM on August 14, 2007 [2 favorites]

It's helpful to reframe the question and the answer to hit on where the guy is going with this.

The intellectual exercise at hand is the question about distributing the disposable income in your pocket. Ideally, you would do this in the most equitable way you could think of, to generate the most amount of good for the most amount of people. Just handing the $10 to the homeless guy helps him, and only him, for a brief moment.

But you could go after bigger fish. After running through various options, one of the answers is "use the $10 in your pocket to make all the dollars in everyone's pockets everywhere more valuable."

The idea is ... if I could make six billion people .00001% of a cent richer, I've utterly maximized the possible amount of "good" that $10 could do.

It's a silly, pointy-headed idea. But there it is.
posted by Cool Papa Bell at 11:10 AM on August 14, 2007

If we operated on the gold standard, then destroying gold (if you could do that) or otherwise taking it out of circulation would increase the value of the gold that remains in circulation.

Fortunately, we do not operate on a gold standard. If you rip up money the Federal Reserve will just print more. No net effect. This actually happens all the time, as money wears out.
posted by alms at 11:26 AM on August 14, 2007

If you rip up money the Federal Reserve will just print more. No net effect. This actually happens all the time, as money wears out.

The Fed does indeed replace old, worn-out notes and coins with new, but that's (ideally) a 1-to-1 correspondence. For every old bill submitted by a bank, a new bill takes its place.

But the Fed doesn't keep tabs on all money everywhere. If you stuffed your mattress full of notes, the Fed doesn't magically know that and replace those notes. Those notes are still "in circulation" when it comes to calculating the total money supply and the value of the dollar. Similarly, if you burned a billion dollars worth of notes, the Fed might notice the change in the dollar's value, and take steps to adjust that given all the other economic activity going on. The Fed may very well elect to ignore the burned notes altogether.

Fun fact: Because the dollar is de facto currency in many parts of the world, that acts as an economic cushion for the U.S. Every dollar note changing hands in Mexico City, for example, is a tiny little loan given to the U.S.
posted by Cool Papa Bell at 11:58 AM on August 14, 2007

It might help to think about this in the reverse. Say that I, a counterfeiter, print up $100 billion in $20 bills. Then I go on a spending spree. I head down to the mall, and I buy everything in it.

All those people at the mall, they all of a sudden have a lot more money. They all head to the local circuit city, and try to buy a big screen TV. All of a sudden, there's a lot more money competing for these televisions. Waiting lists start up, and the owner decides to just jack up the price of televisions by $1000 to thin out the heard some.

The same thing happens (slowly) everywhere. At the grocery store, there's a major shortage of high quality steak, so they start jacking up the price. Eventually, this trickles down so that everything, everywhere, costs more than it used to, and the dollar is worth less. It doesn't have to do with people knowing there's more money out there. It happens because there just is more money out there, and the same number of goods for it to be spent on.

If you don't believe this is how it works, look up hyperinflation. There's a major issue with this going on in Zimbabwe right now, where the government keeps printing up new money, which devalues all the rest of it.

Now, we can reverse it. Imagine someone saves up a boatload of money, but doesn't spend it. He's not competing for the big screen tvs, or the meat, or for anything else, really. By not competing, he's keeping prices from being bid up. If things don't sell, prices will get cut, and he'll be partially responsible for that too.

Again, it's not about knowing or not knowing. The fact that this money isn't in the market means that fewer dollars are competing for the same goods.
posted by kingjoeshmoe at 12:23 PM on August 14, 2007 [2 favorites]

So how does the treasury decide how much money to put in circulation? (Since we're no longer pegged to a concrete substance like gold or silver hoards).
posted by jak68 at 12:40 PM on August 14, 2007

I mean I know the 'dollar' is now sold on the open market and taht determines its relative value, but the treasury could always increase or decrease that value by printing more or less dollars, right? So how do they make that decision on how much to print? Do they have a 'value' for the dollar in mind that they seek to maintain? IS that number pulled out of their arses or is it based on something?
posted by jak68 at 12:43 PM on August 14, 2007

So how does the treasury decide how much money to put in circulation? (Since we're no longer pegged to a concrete substance like gold or silver hoards).

A little bit of research, a little bit of voodoo. This is why Alan Greenspan (and now Ben Bernanke) were such important individuals, and why their every. damn. word. is scrutinized so closely.
posted by Cool Papa Bell at 1:30 PM on August 14, 2007

As a historical note supplementing kingjoeschmoe's illustration, this type of inflation happened when the Spanish brought back tons of gold from the New World and went on a spending spree, causing inflation all over Europe. An excellent account of that episode is here.
posted by beagle at 1:44 PM on August 14, 2007

How does money get into circulation in the first place, anyway? Does the treasury send a bunch of people to go out on the town, buy nice cars, stereo systems, and houses, and then burn it all?
posted by tehloki at 7:31 PM on August 14, 2007

How does money get into circulation in the first place, anyway? Does the treasury send a bunch of people to go out on the town, buy nice cars, stereo systems, and houses, and then burn it all?

Well, it used to be that money literally was gold and silver. Then a long while later, notes were issued that stood in place for the gold and silver in the treasury. Then the notes were replaced by a promise from the government that the notes actually meant something. New money (rather, something of worth that can be traded) is often injected into circulation via the issue of treasury securities and other government bonds.

When a central bank is "easing", it triggers an increase in money supply by purchasing government securities on the open market thus increasing available funds for private banks to loan through fractional reserve banking (the issue of new money through loans) and thus grows the money supply. When the central bank is "tightening", it slows the process of private bank issue by selling securities on the open market and pulling money (that could be loaned) out of the private banking sector. It reduces or increases the supply of short term government debt, and inversely increases or reduces the supply of lending funds and thereby the ability of private banks to issue new money through debt.
posted by Cool Papa Bell at 8:45 PM on August 14, 2007 [1 favorite]

Wow, that's like its own little post. Thanks, Papa Bell. +1 Informative.
posted by tehloki at 9:04 PM on August 14, 2007

fascinating stuff.
posted by jak68 at 10:27 PM on August 14, 2007

when a central bank just prints money and puts it into circulation, that causes inflation and makes all the currency have less value

theoretically depends on the other half of the equation, the amount of goods this money is chasing.

How does money get into circulation in the first place, anyway?

1) The Fed allows a bank to lend more than the cash (or cash-equivalent) reserves that it has on deposit. This ratio is historically 10:1. . . .from a $100 deposit

2) The Fed prints a bond certificate, files it, and wires money into a government account, from which civil service paychecks &/or checks are cut to government suppliers.
posted by Heywood Mogroot at 1:56 AM on August 15, 2007 [1 favorite]

It might be of interest to you to check out monetarism.
posted by biffa at 4:26 AM on August 15, 2007