This week, I’m writing a series of posts on the Somali shilling. Weirdly, the shilling has continued to function in Somalia’s economy for almost three decades, without a Central Bank to issue it. 98% of the notes in circulation are ‘counterfeit’. And according to the academics, the purchasing power of the largest shilling note eventually stabilised at the cost of producing it. That is: the free market economy of counterfeit note production eventually ‘priced out’ the seigniorage profits.
So what is seigniorage?
To answer this question, I’m going to re-visit an old post on minting coins.
In the US, there is a fairly big debate around the $1 note, and whether it shouldn’t be a $1 coin. After all, it’s worth less than £1, and Britain has a coin instead of a note. In fact, Britain also has a £2 coin. So why would one country elect to use a coin where another elects to use a note?
The answer involves seigniorage*, and also explains why there are counterfeiters out there in the world.
*Pronounced sane-your-idge. With a near-silent “d”.
Seigniorage and the cost of making money
Question: Why would a counterfeiter make a fake $1 note?
Answer: Because it costs less than $1 to make.
$1 – cost of making $1 note = Counterfeiter’s Profit
When Central Banks and Federal Governments do the same thing:
$1 – cost of making $1 note = Seigniorage
That’s not the only form of seigniorage*, but it’s the one that’s the most obvious.
*The big seigniorage profits are made during hyperinflations. I wrote about how inflation turns into seigniorage in my post on The Global Currency of Reserve.
It’s part of what gets gold bugs and artists really concerned about bank notes. That “they’re not even worth the paper that they’re printed on”.
When decisions are taken about what type of money to make (ie. notes or coins), the argument boils down to these two options:
- Notes are cheaper to make, but don’t last as long.
- Coins are often more expensive to make, but last a long time (and then get recycled).
Now obviously, given that notes are cheaper, and have to be issued more frequently, it seems like the US authorities are just greedy for more seigniorage revenue. And while that might make sense to the conspiracy theorists – it does make you wonder why the coin-making countries are so… altruistic?
Are they really though?
Well, perhaps not. And to illustrate, I’m going to complain about paying for parking.
- Every time I go to a shopping centre, I collect a parking ticket. And because I am rarely there for longer than an hour, but always there for longer than 15 minutes, the parking machine regularly demands R8 from me.
- This. This is annoying. Because it means that I have to go to an ATM, and withdraw some cash, insert a R50 note into the damned parking machine, only to get R42 change returned to me as coins.
- Those coins go into my pocket, and then get taken out and placed on my bedside table when I get home.
- The next day, I go shopping. Without the coinage.
- I return home with a further R42. In coins.
If we were dealing in notes, I would keep the notes in my wallet. But because we’re talking about coins, I don’t carry them on my person in general. I only ever carry them on purpose – and because my shopping trips are usually en route to something else – I rarely remember to take the coins to pay for parking.
And this is why countries like coins… Because you need so many more of them in circulation. We tend to spend notes quickly – but coins get stuck in jars and forgotten about in drawers. Some estimates suggest that you need 3 to 4 times the value of coins in circulation as you would notes.
Which is why the other countries aren’t really that altruistic at all. It’s just a question of choosing between volume over time and volume as a once-off. And they choose the once-off option.
But what about the Somali shilling?
So in Somalia, without a central bank, enterprising Somali’s began printing their own Somali shilling bank notes. In 1991, the US dollar exchange rate of the Somali Shilling was $0.30 to the shilling. By 2008, the exchange rate had stabilized at $0.03 to the shilling: which, as it turns out, was the cost of producing additional notes.
Which, I guess, means that the Somali shilling is one of the only currencies in the world that is worth the paper that it’s printed on.
Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.