For central banks, crime can pay

Who would have thought you would want to thank your local drug lord?

A recent WSJ article outlines how the black market is keeping the central bank afloat. Higher valued notes, like the €200 and €500 bills, are in high demand, but cost little to produce.

The demand is high because it is easier to conceal large amounts of money with higher notes. The Euro produces the highest, which attracts international demand as well as within the EU.

So, the central bank is profiting by creating money at little cost and selling it back for high premiums. This profit contributes to the central bank’s solvency and therefore helps in preventing a banking crisis.

Not that I condone the government profiting from illegal trade, but it is extremely interesting. The government makes certain goods and practices illegal. The government also gives itself and maintains a monopoly on the production of money. So really, both sides of the transaction (supply and demand) are artificial. It is purely a legal phenomenon.

If you look at this purely in incentive terms, the government should increase enforcement for catching drug dealers and money launderers to where there is a perfect cost effectiveness for the criminals to demand more large bills. If they enforce too much, the underground economy will find substitutes. Of course, this strategy would increase taxes, and not help the economy in real terms.

Still, when looked at closely, the situation say a lot about the leverage of government power and its citizens.

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