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The Underground Economy

Given the holiday and a lot of work to do, it’s time for a repeat.  This one goes with along with my musings on Velocity and Inflation like a hand in a glove – why isn’t there more inflation?  We’ve had a small series this week on that topic, and this brings it back home.  Have a Good Friday and a Happy Easter!

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.

You're declaring all this income, right?

You’re declaring all this income, right?

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.

If all the cash in the economy isn’t part of the Underground Economy, that figure is higher than 3.0, which only makes sense.  Anyone paid biweekly that live paycheck to paycheck will have a personal velocity around 26 every year.  That it comes out to 3.0 based on just the cash part of the world is, if anything, low.

Not everyone can do this.

Not everyone can do this.

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”.

9 thoughts on “The Underground Economy

  1. Farmers in the 1870s and 1880s opposed a monetary policy that favored industrialists and financiers from the Northeast, from New York City.

    These farmers called themselves Populists.

    • Jobs are the most important way out, yes. But as for monetary policy, writing a check to everyone for $10,000 would have cost the Fed about as much as all the QE they did – but would have had far more interesting results.

    • Yup. Very much so. $10k ($3 point something trillion divided by 300 million people) would have caused inflation, but what about $1k? …

      Or, perhaps, $2.56k?

      (joke – oddly specific numbers are always suspicious … 🙂 )

  2. Pingback: The Underground Economy | theThumpHouse

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  4. Pingback: Growth is … ? | Barataria - The work of Erik Hare

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