Home » Money » Cheers for the Underground Economy!

Cheers for the Underground Economy!

“Since we decided to adopt the leaf as legal tender, we have all of course become immensely rich.  But we have run into a small inflation problem owing to high leaf availability. That means the current rate is something like three major deciduous forests buy one ship’s peanut. In order to obviate this problem and revalue the leaf, we’ve decided on an extensive campaign of defoliation and burn down all the forests. I think that’s a sensible move, don’t you?”
– The Management Consultant to Fintlewoodlewix (later called Earth) – “Hitchiker’s Guide to the Galaxy”

It’s good to have a lot of money, assuming that not everyone has a lot.  Inequality is apparently bad when it gets too big, but it also makes the whole economy possible in small doses.  But how much money is really out there, and where is it going?  It turns out that this is more complicated – and hidden – than most thought.

Under-The-TableBarataria has asked these big questions before, such as “What is Money?”, and it really is a matter of belief.  As gold seems to be ready to tumble, professional conspiracy theorist Glenn Beck sees nefarious action, given his belief that “gold is the only real money.”  Nevermind all the fussing and fiddling – to most people the only real money is green on one side and plastered with dead presidents on the other.  And that’s the stuff that is supposed to be going away in an era of plastic, PayPal, and even bitcoin.

Except for one little problem – it’s not working out that way.

It’s been reported in many places (even here) that as much as 2/3 of the $1T in paper money was estimated to be circulating abroad.  Apparently, that’s not even close.  A study by University of Wisconsin economist and professor emeritus Edgar Feige with the Federal Reserve of New York reports that a solid ¾ of that, or about $770B is here at home – $2,200 per person in cash.  What’s all that moolah for?

The answer is that it is the fuel of a roughly $2T underground economy that is largely unreported, unaccounted, and underground.  And it’s only getting bigger as people struggle to make a living in this Depression.

What makes up this underground economy?  Unreported tips, cash payments for services, other things like that.  It’s also drugs and prostitution and illegal activities.  Anyone who has slipped into poverty in the last few years knows just what is meant by it.  It’s money that comes and goes, sometimes easy and sometimes hard.  This is the way that the very poor make it from one payment to the next.  It comes in stacks of Jacksons and sometimes Benajmins, for the lucky.

Where the poor often find a way to get by, there are macro-economic implications for this large and probably growing way of doing business.

It clearly gets by with some fraction of the $770B fueling the $2,000B estimated size.  That’s a velocity of money of around 3.0 or so, depending largely on how much of the cash is really in the hands of those who don’t report it.  They spend it about as fast as they can get it.

One of the features of the Managed Depression has been the collapse of the velocity of money – the rate at which money turns over in the economy.  Overall, it’s about 1.4 times per year, down from over 2.0 during the boomtimes of the 1990s.  But we can estimate that the velocity in the underground economy is at least double that in the economy as a whole.  The terrible problem that the Fed has with declining velocity is solved among those with the least scratch.

That means that the velocity of money is strong function of how much you have, just as it shapes your opinion of what money is.  And that is why inequity ultimately hinders growth – because the more money the poor have the faster the economy as a whole turns over.

Printing more, or in some way increasing the money supply with quantitative easing, does not do the trick.  Sustainable growth comes, at least in part, from a decent turnover of cash in the economy.  That happens easily among the poor, and how they are doing has a lot to do with economic growth because of their amazing contribution to velocity.

When is the end of good old cash?  There will never be one.  It’s still what makes the world go ‘round  – no matter what anyone tells you.  Of course we can’t just make everyone rich by handing them money, but that’s not the side of this problem that we’re on right now.  It’s all a matter of balance and a free market – backed by a solid and available form of this thing called “money”.

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19 thoughts on “Cheers for the Underground Economy!

  1. Bravo! I have seen many blogs on income equality but I have never seen one explain why it is important in plain language before!

    • Thank you! I came to me today while working on something else. A little math on the question of the underground economy and it became obvious that the velocity was at least double the whole economy.

  2. I sometimes wonder if the second reason the government went away from printed food stamps was because that was also used by the poor in an underground economy. Food stamp usage grew and grew in the seventies with the boomers starting out with young kids of their own. Then when Pittsburgh and other steel towns crashed in the eighties Reagan started food banks as a temporary (hah!) band aid.

    • Yes, that is part of the reason I am sure. Food Stamps did become a currency, trading at a discount to face value. It’s amazing what “money” becomes when you don’t have enough of the greenstuff!

  3. I’m going to go out on a limb and say that 2 trillion dollars sounds low for the underground economy. Everyone I know has some cash under the table that they ask me if they have to declare and I always say yes but I know it isn’t. I’d like to know a lot more about where that number came from. But I can see that if that is higher than the velocity has to be even higher yet which doesn’t surprise me. People are living one month to the next very much and spend money as soon as they get it.

  4. Excellent analysis. I have no doubt that money turns over faster for poor people but I have to wonder about the illegal part of the underground economy. They probably have to hold on to stacks of cash a lot longer than an average waitress.

    • You’re right, we should separate out those two. The velocity of money for poor people has to be around 12, which is to say a month’s income goes out in a month – if it isn’t higher!

    • How fast illegal money turns over would depend on the industry and the people. Money spent on prostitution probably turns over rather fast since prostitutes and even pimps are not especially well off. Yeah they may have some fancy bling but they probably don’t have massive stashes of funds. Whereas big time drug dealers probably have to keep a lot more money around in order to make their deals. But minor drug dealers don’t really keep a lot of extra around, many of them need the money from their sales in order to buy more product. So I think the turn over of money in illegal markets probably varies quite a lot between different markets and different players in the market.

      • I am sure you are right. We are all just speculating here at this point, and it’s no substitute for a real study of velocity vs income level. It would be very helpful because it would point to some specific government action, I think. The crashing velocity of the dollar is the biggest problem the Fed faces.

      • I think you are on to something here. I have been saying for a while the economy isn’t picking up faster because it is top heavy. It is the middle and low income people that drive an economy simply because they are the majority of people. With wages stagnating and high unemployment the middle and low income individuals can’t drive the economy like they use to. They aren’t consuming at the same rate. You in a way are saying the same thing just using velocity as the primary focus. I think I will have to look up a bit more about that.

      • I have written about inequality and how it affects growth several times, most recently last week in Inequality vs Sustainable Growth. But this has always left me cold because the main arguments are based on regression lines across national boundaries and/or time. I have been trying to find a good argument as to why this would be the case, and the traditional arguments for sustainable growth based on savings rates, etc, really don’t hold up well. This came to me while reading about the underground economy and how well it is doing.
        So yes, this is my little attempt at a contribution to the arguments. It’s partially baked at this point, so I would appreciate any additions people might have. That’s a lot of what we do here in Barataria. 🙂

  5. Was it you who had the story about jobs in Canada keeping them going ahead of productivity gains? This seems to be the same thing. I agree that unemployment is a big problem and if people make money they will mostly spend it. However most of the analysis I have seen of sustainable growth talks about savings rates which is the exact opposite. Comment?

  6. like this. i think i made the mistake of mulching leaves back into the yard.
    i would hit the like switch on all your articles but my outdated browser won’t let me. i’ve been rendered obsolete, but i still exist…underground.

    will visit your site again. it was fun.

    best wishes,
    griffith

  7. Pingback: Fixing Income Inequality | Barataria - The work of Erik Hare

  8. Pingback: The underground economy | Economics 102

  9. After reading this post I wrote about the underground economy for my own weblog.

    The underground economy is fascinating because it involves civil disobedience, desperation or criminal behaviour.

    My understanding of the underground economy is that it is economic activity that contradicts some legislation and is thus illegal. By this definition, people who live on the economic margins may not be participating in the underground economy as most of what they do is not illegal. How can you break the tax laws if your income is not enough to be taxable?

    Civil disobedience is a complex subject with lots of moral issues and variations. (Are there other ways of protesting a law?) I think of it as deliberately disobeying a law because one disagrees with that law. As most economic legislation works to limit competition so that a few people can make profits they otherwise would not get, there are a lot of unjust economic laws and many opportunities for civil disobedience. Examples include subsidies, trade restrictions,licensing, copyright and patents. Legislation that imposes morals, religious values or sexuality upon people who don’t share those values also invites civil disobedience.

    Economic civil disobedience might be more effective if it were organized and stated to be civil disobedience.

    Generally people living on welfare are living very close to the subsistence margin. As the welfare rules tend to be restrictive the only way these desperate people can get anything extra is to break the rules and/or not declare any extra income they can scrap up. I think a lot of these people are there through no fault of their own. They deserve a lot of sympathy and more generous welfare rates. I believe we should have a collective responsibility to ensure everyone has the opportunity to live the same standard of living as most other people. Illegal immigrants are also probably here out of desperation or because they are better off here illegally than they were in their home countries.

    There is also a double standard in hitting welfare recipients in that wealthy people are good at ensuring tax legislation has lots of loopholes from which they can benefit.

    A third type of underground economic activity is exploitive and/or deliberately criminal. I am thinking of people who employ illegal immigrants and get away with inhumane working conditions because their employees are afraid of deportation. We cannot tolerate inhumane working conditions in Canada or the United States although Bangladesh is somehow different.

    This post was inspired by a post on a weblog by Eric Hare titled “Cheers for the Underground Economy!” I wish there were no need for an underground economy although when we hire neighbors to do some little job for us I usually pay in cash.

    (The author of this comment has a web log on economics at https://economics102.wordpress.com/)

  10. Pingback: Jobs, Now (!) | Barataria - The work of Erik Hare

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