Money Burning – Affect the Economy

Money burning is the purposeful act of destroying money.  Burning money is usually seen as a purely negative act. An individual who compulsively destroys money may be showing signs of mental illness, in which case some legal systems consider a mental health professional justified in restraining him or her to prevent the financial harm.  The cognitive impact of burning money can even be a useful motivational tool, patients who suffer from nail biting may be trained to burn a dollar bill every time they engage in the habit.  On the other hand, there are some situations where burning money might not be so unreasonable.  It is said that the ancient Greek philosopher Aristippus was once on a ship at sea when he was threatened by pirates, he took out his money, counted it, and dropped it into the sea, commenting, “Better for the money to perish because of Aristippus than vice versa.” Cicero would later cite this episode as an example of a circumstance that must be considered in its full context: ” it is a useless act to throw money into the sea; but not with the design which Aristippus had when he did so. A threat to burn money can affect the strategies of the players involved, a classic example is the situation described as ‘battle of the sexes’, where the ability to burn money allows the player to achieve the desired equilibrium without actually having to burn money.  In the prototypical example, banknotes are destroyed by literally setting them on fire.  Burning money decreases the wealth of the owner without directly enriching any particular party.  However, according to the quantity theory of money, because it reduces the supply of money it increases by the same amount the collective wealth of everyone else who holds money.  Money is usually burned to communicate a message, either for artistic effect, as a form of protest, or as a signal.  In some games, a player can sometimes benefit from the ability to burn money (battle of the sexes).  Burning money is illegal in some jurisdictions.

For the purposes of macroeconomics, burning money is equivalent to removing the money from circulation, and locking it away forever, the salient feature is that no one may ever use the money again. Burning money shrinks the money supply, and is therefore a special case of contraction monetary policy that can be implemented by anyone.  In the usual case, the central bank withdraws money from circulation by selling government bonds or foreign currency.  The difference with money burning is that the central bank does not have to exchange any assets of value for the money burnt.  Money burning is thus equivalent to gifting the money back to the central bank or other money issuing authority.  If the economy is at full employment equilibrium, shrinking the money supply causes deflation or decreases the rate of inflation, increasing the real value of the money left in circulation.

Assuming that the burned money is paper money with negligible intrinsic value, no real goods are destroyed, so the overall wealth of the world is unaffected. Instead, all surviving money slightly increases in value, everyone gains wealth in proportion to the amount of money they already hold. Economist Steven Lands burg proposes in The Armchair Economist that burning one’s fortune in paper money is a form of philanthropy more egalitarian than deeding it to the United States Treasury. Banks routinely collect and destroy worn-out coins and banknotes in exchange for new ones.  This does not affect the money supply, and is done to maintain a healthy population of usable currency.  The practice raises an interesting possibility. If an individual can steal the money before it is incinerated, the effect is the opposite of burning money, the thief is enriched at the expense of the rest of society.  One such incident at the Bank of England inspired the 2001 TV movie Hot Money and the 2008 film Mad Money.

Another more common near-opposite is the creation of counterfeit money.  Undetected counterfeit money harms the rest of society by decreasing the value of existing money – one of the reasons why attempting to pass it is illegal in most jurisdictions and is aggressively investigated. Another way to analyse the cost of forgery is to consider the effects of a central bank’s monetary policy.  Taking the United States as an example, if the Federal Reserve decides that the monetary base should be a given amount, then every $100 bill forged is a bill the Fed cannot print and use to buy Treasury bonds. The interest earnings after expenses on those bonds is turned over to the US Treasury, so any lost interest must be made up by U.S. taxpayers, who therefore bear the cost of counterfeiting.  Sometimes, currency intended for use as fiat money becomes more valuable as a commodity, usually when inflation causes its face value to fall below its intrinsic value.  For example, in India in 2007, Rupee coins disappeared from the market when their face value dropped below the value of the stainless steel from which they were made.Similarly, in 1965, the US government had to switch from silver to copper-nickel clad quarter coins because the silver value of the coins had exceeded their face value and were being melted down by individuals for profit.

Related posts: