The Five Stages of Counterfeiting
by Gary North
by Gary North
"If you planned to print up a batch of counterfeit money,
you wouldn’t print triangular bills on orange paper with a picture of Bob Hope on the front."
~ Donald Heath (1960)
The context of Mr. Heath’s observation was the strategy of American
religious cults. Yet for over four decades, I have thought about his insight within its symbolic context: counterfeiting.
The more I have thought about it, the more I am convinced that it needs a modifying clause: "in the first year of your counterfeiting
A truly serious counterfeiting operation would in fact plan to do something
very similar to what Mr. Heath said a counterfeiter would not do – just not in a single step. The goal of a serious
counterfeiting operation would be to persuade the public to use its money rather than the official bills it originally copied
when it designed its original fake plates. Its goal would be the replacement of the original official bills with its own bills,
making them official in the eyes of the public.
This has been the primary goal of central bankers ever since the creation
of the Bank of England in 1694. They have achieved this goal nationally. Internationally, the transition is still incomplete.
In 1694, the primary currency of the British empire was comprised mostly
of gold or silver coins. In the North American colonies, these were Spanish silver coins, the reales ("rayAWLays"). In Great
Britain, there were also bank notes, issued by private, profit-seeking banks, which constituted the initial stage of the counterfeiting
operation. This involved competition among counterfeiters.
The profit-seeking entrepreneurs who set up the Bank of England wanted
a monopoly. So, they traded their promise to purchase government debt certificates with newly created counterfeit money in
exchange for a monopoly grant from the government over the creation of counterfeit bills.
Then began the great substitution, from precious metal coins stamped
with government imprints to small rectangular pieces of brightly colored plastic. So far, Bob Hope’s image is not on
any of them, but one brand is promoted by Mick Jagger, singing about freedom. Frankly, I would feel more confident about a
card with a picture of Mr. Hope.
STAGE ONE: GOVERNMENT COINS
Counterfeiting by private mints has been common throughout recorded history.
The prophet Isaiah warned the residents of Judah, "Thy silver is become dross, thy wine mixed with water" (Isaiah 1:22).
Counterfeiting by governments has gone on for just as long.
Governments early invented a theory of monetary sovereignty. "Only the
government possesses the God-given right to issue coins. All other coin producers inside the state’s boundaries are
The governments defended this with a promise: "You can trust your government
not to mix cheap base metals into the gold or silver metals." Sooner or later, this promise is broken. The only notable exception
was the Byzantine Empire’s gold coinage. From 498 to about 1050, there was no debasing. Then, after half a century of
debasing, there was a reform around 1100. From then until about 1350, there was no debasing. In monetary affairs, those were
the good old days. There have been no others. The closest thing the West has ever had was the era of the international gold
standard, from 1815 to 1914, the years separating two European wars: the end of the Napoleonic wars to the outbreak of World
Governments issue coins with reduced gold content and call them full-value
coins. It spends these coins at yesterday’s prices. The public is not fooled for long. Prices rise.
The scam is based on today’s memory of yesterday’s prices.
The coins initially look the same. They aren’t.
Fact: to get the scam to work, the coins must look the same. As their
precious metal content is reduced, they don’t look the same. Call it the Bob Hope problem.
STAGE TWO: FRACTIONAL RESERVE BANKS
Here is how the system works initially. Private banks issue banknotes
redeemable on demand in gold or silver coins. The bankers make a legal contract. "Deposit your coins with us. You can get
them at any time. We will pay interest to you for your deposit." It is a lie. To get the money to pay depositors interest,
the banks must lend the money. Depositors therefore can’t get their money on demand all at once. The result is a bank
Banknotes with no gold behind them look the same as banknotes that do
have gold behind them. The scam is based on today’s memory of yesterday’s prices.
The bank notes eventually depreciate. Depositors start bringing in banknotes
to demand gold. The counterfeiting bank goes bankrupt.
This realization takes time. There is no Bob Hope problem with banknotes
from the Bob Hope Bank. The late notes look just like the originals. This is also true of checks, which also serve as money.
Problem: the Bob Hope Bank faces competition from the Bing Crosby Bank
and the Frank Sinatra Bank. That is its main problem
The first people who spot the scam are other bankers, who see that their
depositors are depositing lots of banknotes issued by the inflating bank – too many, in fact. So, the bankers start
demanding their gold from the inflating bank.
One solution: state-chartered banks. These have licenses. These are licenses
to steal, i.e., commit fraud. To save their banks, state governments eventually place restrictions on note-redeemability.
But they are promoted initially on a familiar basis: "You can trust a government-licensed bank not to issue more receipts
for gold or silver than it has a prudent quantity of gold or silver in reserve." Prudent quantity. Right.
STAGE THREE: CENTRAL BANKS
A group of very rich investors then see that they may be able to put
the private and state banks out of business, or else force them to deal with them on their terms. So, they petition the national
government to license a national bank. This bank may be granted control over the issuing of bank notes. Or it may be granted
a monopoly of reserving: other banks must deposit zero-interest reserves in accounts at the national bank.
Henceforth, the Bob Hope Bank, the Bing Crosby Bank, and the Frank Sinatra
Bank must stay within note-issuing limits established by the nation’s central bank. Call it the Dead Presidents Bank.
They all have the same old problem. The scam is based on today’s
memory of yesterday’s prices.
In 1914 in Europe and in 1933 in the United States, banknote redeemability
in gold by banknote holders and bank depositors ended. On August 15, 1971, it ended for central banks.
That left silver coins. As fractional reserve money grew in response
to T-bill holdings by the Federal Reserve System, people began demanding payment in silver coins. I was one of them. I bought
$1,500 in silver coins at a local bank in the summer of 1963. Over the next two years, silver coins disappeared from circulation.
The government started issuing copper coins with silver laminate. Call it strumpet money. The public did not care.
STAGE FOUR: CREDIT CARDS
Beginning in the mid-1960’s, banks started mailing out credit cards.
Cards went to just about anyone with a postal address. "Sign up now. Buy now, pay later."
Market penetration was rapid. Tens of millions of people signed up. There
were soon defaults by over-extended card users, but this loss had been factored in before the mailings. The cost of establishing
a new mass market by direct mail was so low that the defaults were chump change for the banks. Within a decade, plastic money
had replaced Dead Presidents and checks in most transactions. Strumpet money – token coinage – was used for soda
pop sales and local sales taxes.
The Bob Hope problem is not completely over. For illegal drug sales,
currency is still needed. But counterfeiters are hesitant to pass along fake bills to users – of drugs and currency
– who will hand over the bills to drug dealers. Dealing with the Secret Service is one thing. Dealing with irate cousins
of Columbian drug lords is another.
Most paper money is mailed to residents in foreign countries by illegal
immigrants working in the United States. It does not circulate here.
So, for all intents and purposes, the Bob Hope problem has ended. The
legal counterfeiters no longer face private counterfeiters.
STAGE FIVE: THE PUBLIC PERCEPTION PROBLEM
On July 10, 2007, Federal Reserve Chairman Ben Bernanke delivered one
of the most revealing speeches in the history of central banking: "Inflation Expectations and Inflation Forecasting." He delivered it to the National Bureau of Economic Research (NBER), which is the original privately funded think tank devoted
to gathering economic statistics. It is the government-recognized agency that reports retroactively when an American recession
began and ended.
The speech admits a great deal. The main thing it admits is that the
staff economists of the Bank have no precise formula or data set which they use to predict price inflation. They have reams
of data, but no operational theory to interpret these data.
The Board staff employs a variety of formal models, both structural and
purely statistical, in its forecasting efforts. However, the forecasts of inflation (and of other key macroeconomic variables)
that are provided to the Federal Open Market Committee are developed through an eclectic process that combines model-based
projections, anecdotal and other "extra-model" information, and professional judgment. In short, for all the advances that
have been made in modeling and statistical analysis, practical forecasting continues to involve art as well as science.
If these guys were a rock band, they could call themselves "Doctor B
and the Wing-Its."
It was a long speech. He went into detail about the kinds of statistics
they look at in order to make predictions. His main topic was the public’s ability to predict price inflation. This
is a concern for the FED because what the public expects prices to do affects the selection of monetary policy by the FED.
We are no longer dealing with the Bob Hope problem. Digits do not have
faces. The public cannot distinguish one digit from another. Neither can private bankers. There are no runs on banks these
days because the only people using currency are illegal immigrants who do not deposit their money in banks. The senior counterfeiter
has finally overcome the ancient problem of money recognition.
It has not overcome the problem of price recognition.
Repeat after me: "The scam is based on today’s memory of yesterday’s
It is also based on today’s forecast of tomorrow’s prices.
Bernanke is convinced that the public after 1983 has had ever-lower expectations
of price inflation. This is good, he said.
More fundamentally, experience suggests that high and persistent inflation
undermines public confidence in the economy and in the management of economic policy generally, with potentially adverse effects
on risk-taking, investment, and other productive activities that are sensitive to the public’s assessments of the prospects
for future economic stability. In the long term, low inflation promotes growth, efficiency, and stability – which, all
else being equal, support maximum sustainable employment, the other leg of the mandate given to the Federal Reserve by the
Note what he thinks is a good thing: low inflation.
Why not zero inflation?
Why not price deflation? "What’s good for computer buyers is good
for buyers of everything else!" Right?
That is not what Bernanke thinks. If he did, he would say so.
That is also not what any Ph.D.-holding economist quoted by the media
or published in academic journals believes. I have heard only one academic economist come out publicly in favor of price deflation:
Murray Rothbard. He favored a monetary standard selected by the public voluntarily in a world in which the fraud of fractional
reserve banking is illegal. He believed that increasing productivity under capitalism in a 100% reserve ratio legal system
would lead to slowly falling prices.
On this issue, Rothbard stood alone in the twentieth century.
So, the public wants low price inflation. Anyway, that is what the FED
intends to provide. So, the FED’s policy-makers require reams of statistics, collected by government fiat. They also
require computer models. And they require an undefined and therefore uncertain artistry to work consistently, contrary to
Bernanke politely said that pre-1980 Keynesian policies of inflation
to combat unemployment are dead. This is surely good news – for now.
Still, I think we can agree that, at a minimum, the opposite proposition
– that inflationary policies promote employment growth in the long run – has been entirely discredited and, indeed,
that policies based on this proposition have led to very bad outcomes whenever they have been applied.
But we still have price inflation. We have had price inflation every
year, except 1955, since 1938. Why? Because the FED keeps inflating the monetary base, and the commercial banks keep responding
by inflating the money supply. Why does the FED do this? To keep the economy from falling into recession.
So, contrary to Dr. Bernanke, I think we can agree that, at a minimum,
the opposite proposition – that inflationary policies promote employment growth in the long run – has been entirely
accepted by the academic economics guild, despite the fact that policies based on this proposition have led to very bad outcomes
whenever they have been applied. It has surely been the operating presumption of Federal Reserve policy-makers since 1933.
As you know, the control of inflation is central to good monetary policy.
Price stability, which is one leg of the Federal Reserve’s dual mandate from the Congress, is a good thing in itself,
for reasons that economists understand much better today than they did a few decades ago.
What I know is that price stability has been the fairy-tale dream of
Federal Reserve chairman ever since 1938, which they promise to Congress, four times a year. They have been singing a variant
of Snow White’s love song ever since its release in 1937: "Some
day, price stability will come." And Congress, doing its now-legendary imitation of Dopey, smiles contentedly.
Bernanke says that the public learns about price inflation over time.
The public learns to forecast. He says the FED needs models and data to learn how well the public has learned. Why? To assess
its own credibility.
A fuller understanding of the public’s learning rules would improve
the central bank’s capacity to assess its own credibility, to evaluate the implications of its policy decisions and
communications strategy, and perhaps to forecast inflation. Realistically calibrated models with learning would also inform
our thinking about policy and the economy.
If the FED were really concerned about its credibility, it would do the
- Post on its Website the minutes of any meeting of the Federal Open Market
Committee no later than 24 hours after the meeting adjourned.
- Release to the general public the computer programs used by the FOMC
to assess the economy.
- Release to the general public the data gathered at government expense
and at FED expense as soon as this information is downloaded into FED data bases.
In short, we want transparency. And why shouldn’t we? Isn’t
transparency a great thing? That’s what Bernanke told a Congressional committee on July 18.
Chairman Frank, Ranking Member Bachus, and members of the Committee,
I am pleased to present the Federal Reserve’s Monetary Policy Report to the Congress. As you know, this occasion marks
the thirtieth year of semiannual testimony on the economy and monetary policy by the Federal Reserve. In establishing these
hearings, the Congress proved prescient in anticipating the worldwide trend toward greater transparency and accountability
of central banks in the making of monetary policy.
So, let’s have even more transparency. Let’s end FED secrecy.
No more 45-day delay in releasing FOMC minutes. Let investors have access to the tools used by the FED’s policy-makers.
Bernanke told the NBER, "the staff’s long-term track record in
forecasting inflation is quite good by any reasonable benchmark." So, let’s add another benchmark: public access to
the tools used by the FED to make policy. Bernanke praised "a market in which investors back their views with real money."
Let’s expand that market. Right?
Oh. I see. Sorry I asked.
First, the public had the Bob Hope defense for coins: people could spot
counterfeits. That defense was removed by banknotes.
Second, other bankers had the Bob Hope defense: they could count specific
banks’ banknotes being deposited by their clients. That defense was removed by state-licensed banking.
Third, the public had the Bob Hope defense for coins: people could still
make a run on the banks. That defense was removed by making gold coins illegal and silver coins counterfeits.
Fourth, the public had the ability to perceive and
forecast price inflation. This ability remains. The FED does whatever it can to figure out what the public will expect next.
Most important, it keeps its activities and plans secret. But, step by step, word is getting out. The dollar is falling. The
government’s debt is rising. The Web is snooping.
Congress, however, is still Dopey.