Economics of counterfeit notes

If you are trying to sell $200 million of nearly flawless counterfeit $20 currency notes, there is only one real buyer – the US government itself. That seems to be the moral of a story in GQ Magazine about Frank Bourassa.

The story is based largely on Bourassa’s version of events and is possibly distorted in many details. However, the story makes it pretty clear that the main challenge in counterfeiting is not in the manufacture, but in the distribution. Yes, there is a minimum scale in the production process – Bourassa claims that a high end printing press costing only $300,000 was able to achieve high quality fakes. The challenge that he faced was in buying the correct quality of paper. The story does not say why he did not think of vertically integration by buying a mini paper mill, but I guess that is because it is difficult to operate a paper mill secretly unlike the printing press which can be run in a garage without anybody knowing about it. Bourassa was able to proceed because some paper mill somewhere in the world was willing to sell him the paper that he needed.

The whole point of anti counterfeiting technology is to increase the fixed cost of producing a note without increasing the variable cost too much. So high quality counterfeiting is not viable unless it is done in scale. But the distribution of fake notes suffers from huge diseconomies of scale – while it is pretty easy to pass off a few fake notes (especially small denomination notes), Bourassa found that it was difficult to sell large number of notes at even 70% discount to face value. He ended up selling his stockpile to the US government itself. The price was his own freedom.

To prevent counterfeiting, the government needs to ensure that at every possible scale of operations, the combined cost of production and distribution exceeds the face value of the note. At low scale, the high fixed production cost makes counterfeiting uneconomical, while at large scale, the high distribution cost is the counterfeiter’s undoing. That is why the only truly successful counterfeiters have been other sovereigns who have two decisive advantages: first for them the fixed costs are actually sunk costs, and second, they have access to distribution networks that ordinary counterfeiters cannot dream of.

Posted at 9:09 pm IST on Sat, 1 Nov 2014         permanent link

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