New $20 Bill - Problem For Drug Dealers, Profits For US Government

[MORTARDUDE]

http://www.nypress.com/16/51/news%26columns/feature.cfm

Fancy Greens, Pusherman Blues

Why the new Jackson spells problems for your local dealer?and more tax dollars for Uncle Sam.


The subtle effectiveness of the new $20 bill as a post-recession market stimulant is something the Federal Reserve System is not taking credit for.

In fact, no one is taking credit for it. Not the Fed, the FBI or the Secret Service?which was originally created to handle counterfeiting, not presidential security. None of these agencies admits to seeing so much as a memo suggesting that the introduction of the new twenty would wind something of a nervous timer in the minds of people sitting on large sums of old twenties, creating a paranoid deadline to decommission conspicuous sums of old bills from their untaxed "underground economy."

The U.S. is making an incalculable profit on the roll-out of the snazzy new twenties, a profit that remains unarticulated in the Fed?s frontline campaign that explains the currency?with its watermark, security thread and color-shifting ink?solely as an anti-counterfeiting measure. What?s not being said is that the new twenty puts the zap on the heads of people who routinely reintroduce hefty wads of currency from the underground economy to the aboveground one: money launderers and hoarders operating from considerable private cash holdings.

These people will tell you that the new look of money is the new status quo, and if they don?t want to be noticed, they?d better stay in step with the new status quo.

In New York City alone, wholesale drug resellers as close as two tiers above street-level distribution have begun asking buyers to separate older twenties from new ones to more quickly direct the old currency at laundering operations and retail purchases. The result is an accelerated rate of tax revenue for the U.S. government, one that it would not be enjoying if crime weren?t convinced that moving the old bills aboveground sooner rather than later means one less way to be detected by law enforcement. It?s a dynamic not without precedent.




In the final months leading to the introduction of the euro, currency circulation in Europe actually shrank by a quarter. "[People] worried that they would get in trouble for trying to convert large hoards of old notes into euros," explained Ken Rogoff, a Harvard economist and former chief economist for the International Monetary Fund. Rogoff recalls that in the rush to beat the arrival of the euro, housing prices in the Netherlands were actually bid upward as piles of old currency were directed at that market.

According to Rogoff, big players in the U.S. underground economy are likely in the process of purging old twenties in a scramble to avoid suspicion, a paranoia similar to that of pre-euro Europe. "It certainly inconveniences heavy users of hoarded cash," Rogoff said of the new note. And he expects even more inconvenience as the new fifties and hundreds are rolled out in the next two years.

One Manhattan drug dealer told New York Press that the dollar value of old twenties in his hoarded "business account" nearly equals that of Michael Jackson?s bail. A truckload of dough comes to mind, but Pete?s cache of almost $3 million doesn?t even top off a duffle bag. Besides, it?s not the physical size of the money stash at issue; it?s the cost and inconvenience of having to reduce his count of old bills that irks Pete.

Unlike post office stamp machines that stick you with those pesky Pocahontas dollar coins when they dispense change, opportunities to dispense old twenties as change in a drug deal don?t occur frequently enough in the exact-change world of a pot purchase.

So Pete makes a concerted effort to spend only old twenties while laundering the balance at a rate of approximately $7500 a month (for the next 12 months, he projects) through a number of mostly retail, private businesses. Because the cash passes through the register, Pete and his associates get hit for income tax on the laundered money.

"Our stores will have a good year next year. It?ll definitely look like the economy is picking up."




Is there a way to discover how much profit the U.S. is realizing from the accelerated exposure of previously underground money to taxation? Let?s start by asking how much the underground economy is worth.

In a 2000 International Finance Discussion Paper for the Board of Governors of the Federal Reserve System titled "Here, Dollars, Dollars: Estimating Currency Demand and Worldwide Currency Substitution," author Brian Doyle illustrates that a global underground economy composed of all styles of tax evader is loaded with billions of unaccountable twenties, fifties and hundreds. But, like most academic efforts to take a stab at its size, Doyle admits that a lack of data plagues attempts to measure the underground economy.

"Though there exists reports detailing the movements of currency through banks of amounts greater than $10,000, there is no record of potentially countless ?briefcases full of cash? that travel across the border, or the multiple transfers of just under $10,000 to avoid reporting requirements," he writes.

No one knows the size of the underground economy. Despite numerous efforts, there lacks a "unified theory" of how to get one?s hands around it, according to a group writing for the Journal of International Affairs in a Spring 2000 article titled "The Shadow Economy." In it, authors Matthew Fleming, John Roman, and Graham Farrell recognize the taboo, symbiotic relationship between the above- and underground economies. They ask: "To what extent does the exclusion of the (underground) economic activity distort official estimates of macroeconomics variables, including output, employment and inflation?"

The authors even cite work by Edgar Feige, who claims the recession and unemployment of the 1970s and early 80s was "a mirage" due to a shift by many?be they drug dealers or day laborers?to the underground economy.

Rogoff pins some numbers on it. He estimates that at the beginning of 2002, the currency per capita?that is, the amount of cash held by the public?was in excess of $620 billion. That works out to about $2200 in cash for every man, woman and child in the country. And that?s cash on hand, not some number on a bank statement.

"I don?t know about you," Rogoff says, "but I don?t usually carry one-tenth that much currency in my wallet."

Consider that well over half of that $620 billion is held in $100 bills, and Rogoff discovers that (per capita) the typical American family should be holding approximately sixty $100 bills. However, a Federal Reserve Board survey at the end of 2001 found that your average American family doesn?t have even one Franklin laying around. "Where?s the missing money?" asks Rogoff.

The Fed should have some idea. After all, the Fed doesn?t just crank out an arbitrary number of new notes like the twenty; it buys them from the Bureau of Engraving and Printing for about four cents each. It knows how many it distributes to the public. It tracks their serial numbers through banks. And it must pledge collateral in the form of U.S. Treasury securities for every dollar issued.

But the Fed, with all due respect, is playing dumb.

Eugenie Foster, a project leader with the division of Federal Reserve Bank Operations and Payment Systems said she was "unaware that any U.S. government agency maintains specific records on hoarded currency," and that "without knowing whether there are unaccountable older twenties, it is difficult to speculate on any impact of forcing them into the economy." She suggested the question be directed to the FBI or the U.S. Secret Service, "the federal agencies that have jurisdiction over financial crimes."

But the act of spending money that gets taxed at a register is not a crime. If anything, the all-welcoming, open-for-business nature of a cash register makes it one of the more open borders of the underground economy, and criminal cash that crosses that border finds amnesty. In the process, sales-tax revenue is exchanged in the symbiotic relationship between the above- and underground economies suggested by Fleming, Roman and Farrell. It becomes a key mechanism in that "statistical opaqueness that is part and parcel of criminal and informal transactions."

Such transactions are also the key to a little-recognized form of seignorage. Call it paranoid seignorage: a spike in tax revenue from resurfacing notes when the government refreshes its currency. Think of it as yet another way the government makes money from making money.

Seignorage is the difference between the value of money and the cost of its production. In the case of notes, the Fed buys at four cents apiece and sells them to banks at face value; dollar coins possess only a fraction of their value in raw materials. It?s easy to see a profit mechanism in place, but an important distinction should be made concerning the profit conundrum of paranoid seignorage and traditional seignorage, which some experts dismiss because the securities (bonds) acting as currency collateral are just IOUs.

Some argue that there?s no profit to simply replacing old twenties with new ones, at least not if you think of it in an aboveground scenario involving a domestic bank teller. As Ernest Ankrim, a chief investment strategist with Wall Street?s Russell Investment Group, explains: "If I were sitting on a million dollars in twenties, maybe for contract killings, and if my objective is to replace the old twenties with new twenties that I?m just going to hoard again, then the economic stimulus really isn?t there." New hoard replaces old hoard, simple enough.

It?s thought, however, that currency leaving the U.S. represents a more obviously profitable form of seignorage, as post-Keynesian economic theorist William Hummel writes: "For a few cents worth of paper, the [U.S.] notes buy foreign goods and other assets at their face value, and as long as those notes remain overseas, those assets are effectively cost free." Hummel believes he?s pinpointed a pure form of seignorage, but by his own admission loses the trail when it comes to who benefits from the seignorage of U.S. currency abroad.

Paranoid seignorage is simpler to understand. It?s all about tax revenue, unequivocally making the U.S. government the beneficiary of distributing a new $20 bill.




In the first wave of the release of the new twenty in October, more than $1 billion in the notes hit the streets via bank tellers, ATMs and the like, according to the Fed. They estimate that it will take six months or so before the new design comprises 20 percent of the twenty-dollar notes in circulation?about $5 billion in total.

In a typical currency upgrade, such as the one we are experiencing right now, Rogoff estimates that anywhere between 15 and 20 percent of the money "never comes home." It falls into caches of currency like the "account" that "Pete" maintains for his drug business? operating expenses.

Using Rogoff?s formula, approximately $50 million worth of the new twenties will eventually settle into the underground economy.

Can we then expect the government to see an increase in revenue equal to the sales tax on $50 million as the older twenties in the underground economy get registered back into the system? The figure must certainly be lower, unless of course the underground economy is rapidly growing.

Again, nobody seems to know.

What is known is that substantial players in the underground economy are distancing themselves from old notes as new currency arrives, and complaining that a tax burden has been placed upon them in the process. The paranoia motivating their behavior falls under the category of Fleming, Roman and Farrell?s "macroeconomics variables," as paranoia affects everything from interest rates to the discipline of personal savings.

"The Fed could shut the whole drug trade down in 72 hours," one dealer told New York Press. "Worldwide, everything. They just let dealers exist because they profit on us."

This is the view of paranoid seignorage from the other side of the looking glass, a point of view that sees a clear path connecting the above- and underground economies. But ask Secret Service Special Agent Shannon Zeigler if he sees the same connected path, and his voice echoes over the phone like a recording device has just been triggered.

"It sounds like a theoretical application," he says. "Our mandate is to stop counterfeiting."

Zeigler got the first part right. The detection of paranoid seignorage is as elusive as any other form of seignorage; for that matter, pinning it down can be as frustrating as the statistical opaqueness of the underground economy itself.

Still, why wouldn?t the Fed, FBI and Secret Service find incentive from the current administration?s crusading posture to take easy credit for the new twenty?s full suite of crime-fighting measures?