Counterfeiting money is the stuff of television, movies, and lore, but hardly seen by most of us – for only about one in ten thousand notes is found to be counterfeit annually.  But long ago, it was a big deal – for instance, playing a major role in the Revolutionary and Civil Wars. And nowadays, while it only directly costs Americans about $60-$80 million a year, the Treasury acts as if it is a multibillion dollar potential crime. And of course, counterfeit checks is a major crime, and source of the Nigerian schemes that pepper our email spam boxes.

My coauthor, Elena Quercioli (visiting Bocconi, soon teaching at Central Michigan), experienced the reality of counterfeiting beyond our borders in Mexico City. A merchant once informed her that a few hundred dollars worth of pesos that she had just been issued at an ATM was all counterfeit. In the USA, she would have lost the money, and been questioned by police. But there, she retained her pesos, and proceeded to find a “greater fool” upon whom to unload her losses – the crime of “uttering” (which we are told is extremely hard to prosecute even in the USA).

Elena saw that her misadventure pointed to an interesting paper on counterfeit money that might atone for her mild transgressions. The small literature on this topic never modeled the costly vigilance choice of individuals in dealing with counterfeiting. She proceeded to convince the Secret Service to give her a data trove on counterfeit dollars.  She pieced together a larger and hitherto partially unknown picture about the two flavors of counterfeit money – namely, seized money – that is confiscated from bad guys before it enters circulation – and passed money that is found at a later stage, and leads to losses by the public. Among her findings:

#1. The ratio of all counterfeit money to passed counterfeit money rises, but less than proportionately with the note.

#2. The per transaction passed rate (as a fraction of the circulation) is small for low notes, dramatically rises, and then levels off or drops. In Europe, for instance, the counterfeiting of the 500 Euro note is miniscule compared to the 200 Euro note.

(The Secret Service is under the mistaken impression that the $20 is the most counterfeit, as it fails to understand that the $50 and $100 notes circulate much less often. Go figure.)

#3. Since the 1970s, the  ratio of all counterfeit money to passed counterfeit money has drammatically fallen about 90%.

#4. The fraction of counterfeit notes found by Federal Reserve Banks falls in the note.

I found these facts and intimations of a new theory very appealing. Our joint paper creates what may be the first multi-market “large game”, i.e. two interacting games each with a continuum of players. First, “bad guys” do battle with “good guys” in a massive game of cat and mouse. In it, good guys choose their vigilance effort  and bad guys choose their counterfeit quality – where greater quality better frustrates counterfeiting efforts. Second, since some fake money inexorably passes into circulation, a collateral game is induced, this one pitting good guys against one another. Such a hot potato game is one of “strategic complements”: Fixing the counterfeiting rate, the more carefully I expect the next guy to examine his notes, the more carefully I must. We show that this second market fixes the counterfeiting rate.

The whole exercise has proved an exploration of nanoeconomics – for instance, we can deduce that individuals expend at most ¼ a cent of vigilance attention looking at the $100 note, and much less for lesser notes. I must say that the paper has reinforced my faith in economics. For despite such miniscule attention costs, the theory does a decent job of simultaneously explaining all the above patterns in counterfeiting – for instance, even the nonmonotone one emerges, that the passed rate rises and then falls. We even do a darn good job absolving the Secret Service of any incompetence in the plummeting seizure rates.

1. “I have given up. Letters have gone to both referees requesting the return of your manuscript to this office right away. I hope to God I can have better luck with the next people. I don’t know whether this is a matter of concern to you, but let me assure you that it is my intention not to publish the paper by Arrow and Debreu (which has also been submitted) before the publication of your paper (if both are found acceptable). I think this would only be fair to you.” – Econometrica Editor Robert Strotz’ 1953 letter to Lionel McKenzie on his existence proof for general equilibrium
2. I had a fun conversation over dinner with Alessandro Lizzeri (outgoing AER coeditor) at the 2011 Winter Meetings in Denver. He had a fine insight about the economics graduate education: Economics grad students start out learning the classics in first year, absorb the stock of highlights from the last ten years in second year, and then start coming to field seminars, seeing the quasi-shitty flow of marginal new ideas … and we wonder why they are jaded.
3. “Wanna see who lives in Einstein’s House now? Visit Princeton on Hallowe’en night ….. the current genius, Dr. Eric Maskin dresses up like Einstein and gives treats out to Princeton kids.”