Paper Money: Crisp and Even

January 1st sees the biggest-ever introduction of new banknotes on a single day. It may go smoothly.
Economist StaffDecember 21, 2001

The scale is mind-boggling. Over the past few months, some 14 billion brand-new notes, ranging in value from euro500 ($440) down to euro5, have been printed by the 12 countries that have adopted Europe’s single currency, the euro. As many as 10 billion of these notes will be introduced on January 1st 2002 (a public holiday throughout Europe), accompanied by the simultaneous release of 50 billion new coins. It adds up to what the European Central Bank claims is “the biggest logistical exercise in peacetime”.

Little wonder that plenty of gloomsters foresee chaos. There are predictions of massive queues at railway stations and post offices; of elderly (and not-so-elderly) shoppers befuddled by the new currency — not least by conversion factors that perforce run to six decimal places; of confusion because old notes in national currencies will continue to circulate for periods varying between four and eight weeks, depending on the country; and of sharp retailers taking advantage of the situation to raise prices and short-change customers. Worse, Europe’s criminals will be hard at work exploiting what may be the greatest opportunity in history to pass forged banknotes.

In all likelihood, most of the doomsday talk will turn out to be as overblown as was the millennium bug. But the history of paper money is decidedly chequered, and few of today’s big issuers of the stuff have solved all the problems that come with it.

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Paper Dreams

Gertrude Stein once said that “the thing that differentiates animals and man is money”. The search for a means of exchange is almost as old as mankind. Coinage was invented by Croesus, king of Lydia, who became so fond of it that he soon also pioneered its debasement. Among commodities tried have been chocolate (the Aztecs), cowrie shells (Pacific islanders), butter (Norsemen) and salt (from which the word salary is derived). In Europe after the second world war cigarettes were used, and in Italy it was common as late as the 1970s to use sweets as small change.

Paper money has an extra hurdle to jump, compared with commodities, coins or even sweets: the credibility of something with no inherent value. Even so, the notion of using paper as money is almost as old as paper itself. The first people to do it were the Chinese, who printed the earliest banknotes over 1,000 years ago. Rather like Croesus before them, they soon grew so fond of their invention that they also pioneered excessive monetary growth, triggering inflation. As long ago as the 11th century, the issuance of banknotes led to a depreciation that, one historian of China, L. C. Goodrich, has argued, rivalled conditions in Germany and Russia after the first world war.

The most famous Chinese issuer of paper money was Kublai Khan, the Mongol who ruled the Chinese empire in the 13th century. Kublai Khan decreed that his paper money must be accepted by traders on pain of death. As further encouragement, he confiscated all gold and silver, even if it was brought in by foreign traders. Marco Polo was impressed by the efficiency of the Chinese system. Yet for all the threats, paper money did not succeed everywhere. In Persia, its forcible introduction in 1294 led to a total collapse of trade. By the 15th century even China had more or less given up paper money.

In Europe, the honour of being the first issuer of paper money belongs to Sweden, where in 1661 Johan Palmstruch’s Stockholm Banco introduced the first banknotes. Yet after a splendid start, the bank overextended itself and had to call in government aid; Palmstruch himself was sentenced to death (later commuted to life imprisonment) for mismanagement. Despite this example, other European countries soon followed the Swedish lead. One reason for establishing the Bank of England in 1694 was to print paper money, often in the form of “running cash notes”, the balance of which could be kept in an account. The Bank is now the longest continuous issuer of banknotes in the world.

As elsewhere, however, many experiments ended in disaster. The best-known was the brainchild of John Law, a Scot who in 1716 persuaded the Duke of Orleans, then regent for Louis XV, to let him start a bank and issue notes as a way of boosting the French economy. The Banque Royale, as it officially became in 1718, was a roaring success at first, especially when it became linked to Law’s Mississippi company. But when it was noticed that Law had issued twice as much currency as France’s total supply of gold and silver, confidence and the bank both collapsed, and Law headed into exile.

French suspicion of paper money persisted up to and beyond its revival in the 1790s. The notorious assignats issued by the revolutionary government were promptly depreciated, just as Law’s notes had been. Well into the 20th century, and even today, France has maintained a stronger attachment to gold than have most other rich countries.

The real masters of paper money, however, were on the other side of the Atlantic. As John Kenneth Galbraith has put it, “if the history of commercial banking belongs to the Italians and of central banking to the British, that of paper money issued by a government belongs indubitably to the Americans.” And the father of American paper currency is indubitably Benjamin Franklin, the man who features on today’s $100 bill. He was a printer who, like Law, was a fervent advocate of the benefits of paper currency.

As usual, though, things went too far. By the mid-18th century, several colonies had issued so much paper currency (Rhode Island being the champion depreciator) that London was forced to intervene on behalf of long-suffering creditors. All issues of banknotes were banned in 1764 — one of the tyrannical acts that helped trigger moves to independence. To pay for the war of independence itself, the colonies issued a whole lot more paper, which rapidly became devalued.

As in France, this unhappy experience led to a suspicion of paper money that lasted for generations. The constitution adopted in 1789 banned the issuance of paper money by any state. In the 1830s, Andrew Jackson vetoed the establishment of a central bank, which is why America did without one until 1913. During the civil war, both sides yet again resorted to paper money, and once again inflation ensued. The confederacy’s money, in particular, suffered almost as spectacular a depreciation as did the German mark in 1923. Even the populist movement of the 1890s could trace some of its roots to the paper-money disasters of previous generations.

The Forger’s Art

Most of this gloomy history reflects the failure of governments to follow Ricardo’s simple 1817 dictum in “Principles of Political Economy and Taxation”: “It is not necessary that paper should be payable in specie to secure its value, it is only necessary that its quantity should be regulated.” We need no longer worry that the ECB or the national central banks in Europe will overissue their paper currency. But there is a second danger likely to affect the euro, and to do so almost immediately: forgery.

Forgery is as old as paper money. Its appeal is obvious enough: because paper is intrinsically worth nothing, passing it off as currency can be hugely rewarding. Issuers have always been plagued by forgers. In the early 19th century, the Bank of England devoted huge resources to detecting forgeries, advising the public how to avoid them and catching their perpetrators, most of whom were hanged.

Later in the century, several central banks suffered from the attentions of perhaps the greatest forger of all time, Leon Warnerke. Warnerke, who may have been either Russian or Moravian by birth, was to outward appearances a respectable photographer and businessman, living in a comfortable villa in south-east London. But in fact he was the kingpin in a loose group of anarchists and ex-communards; and he was a highly successful forger of various east European banknotes, especially Russian roubles. He was never caught and had countless identities — and there is even evidence that he managed to fake his own death in 1900.

The hardest part of forgery is often not the reproduction of the notes, but their distribution. It is because distribution requires good organisation that the most effective forgeries have often been undertaken by governments themselves. In the war against revolutionary France, for instance, the British made hay by forging assignats, contributing to the inflation that followed their introduction. Forging the other side’s currency has become a standard (and often devastating) war tactic. It was used against Saddam Hussein in 1990-91; it has also been used this year against the Taliban in Afghanistan.

The most brilliant case of forgery in wartime was that of the Nazis against Britain in the second world war. The Germans used skilled counterfeiters in prison, notably in the Sachsenhausen concentration camp. They also manufactured superb paper (the paper that goes into a banknote can be the hardest thing to forge: Warnerke was a master paper maker). When the notes started to appear, the Bank of England was deeply worried by their quality. It is said that the only distinction between the best German forgeries and the real thing was that the former were perfect: genuine notes all had blemishes.

Designs for Living

The European Central Bank is well aware of this history. Indeed the threat from forgers is one reason why it kept the detailed design of its new notes under wraps for so long. It also explains why it was anxious not to allow any notes to reach the public before January 1st — and why police forces in various countries have been so energetic in pursuing the few cases there have been of robbery of the notes. And it is part of the response to those who have complained about the dull design of the notes: for all banknote issuers, retorts the ECB, security comes ahead of aesthetics.

For the euro, there are four layers of security. First are a few simple features — such as watermarks and security threads — that are relatively easy for the general public to spot. A further seven or eight more elusive points will be drawn to the attention of Europe’s 5m or so professional cash handlers. Third come features to help automated machines to tell real notes from false ones. And lastly there are some aspects of the design that only experts from central banks will be able to detect. All except this last category will be publicised after January 1st.

Yet there is a flaw inherent to all such security measures. As Peter Bower, a forensic paper analyst, puts it, “all security features are designed by experts — and the public doesn’t know about them.” This will remain true despite the most lavish of publicity campaigns. Forged notes are often passed in ill-lit places such as bars and pubs. Mr Bower estimates that perhaps 3% of banknotes in west European countries may be forged, and that the proportion is rising. For the American dollar, which circulates widely outside the United States, his guess is more dramatic: as much as 30% of the notes circulating in Russia, Eastern Europe, Africa and elsewhere may be forged.

In one sense, forgery is getting easier, not harder. Personal computers and colour-printing drum scanners have made the copying of anything much easier than it was. Yet there are still ways of staying ahead in the cat-and-mouse game of issuer and forger. One is through tight control of the paper. The three best-known manufacturers are Crane’s, in Massachusetts, Portals in Hampshire, England, and Chamalières, in the Auvergne. De la Rue, the owner of Portals, is the biggest commercial banknote printer in the world, with clients in 150 countries. Portals has supplied the Bank of England since 1742, and it says it has never had any paper stolen, although others claim that it did happen once in the 19th century.

Another way of foiling the forgers is through the choice of design and colour. For years green was the hardest colour to copy, which is why the Americans used it — hence the term “greenback”. Some intricacies of design can be hard to copy too — although the most handsome notes are not always the hardest to reproduce. Plastic notes, as used in Australia and now in Brazil, are another way forward, but experts say they too can be forged, and many users dislike them.

A third way of defeating the forgers is to change your notes frequently. And, although few central banks like to admit that forgery is a problem at all, it is striking that many have speeded up the rate at which they introduce new notes. Typically, banknotes used to remain in circulation for 15-20 years, and designs might change even less often. Now notes usually stay in circulation for less than ten years; and design changes are made more often still. New denominations are less common (and not always successful: as many as 600m of the 770m ¥ 2,000 notes introduced by the Bank of Japan in 2000 are back in its vaults). But most countries have gradually replaced their smallest denomination notes with coins.

There is a glaring exception to this, however: the United States. Banknote experts despair of America’s longstanding refusal to modernise its notes, or even to change them much. The Americans retort that, unlike most, they have never in history stopped honouring any of their notes — but then neither has the Bank of England. Besides being dull and relatively easy to forge, different denominations of dollars are hard to tell apart. Yet even in America, some changes have been introduced to deter forgers: the current $100 bill has a slightly enlarged and off-centre portrait of Franklin.

One final way to beat the forgers is even more drastic: do without notes at all. Yet the merits of plastic cards, Internet money or e-cash have been touted for many years without appearing to make much impact on the demand for paper money. If anything, the pattern has been for these new forms of money to replace not cash but cheques. Demand for paper money has been rising, not falling, as countries have got richer.

The Best and the Brightest

So who has the best banknotes? Almost everybody would agree that America’s should be at or near the bottom. Top position depends, naturally, on taste, although it is often the more obscure countries, such as Guatemala, that print the most attractive notes. Many poor countries’ notes, especially some of those in Africa, have more or less crumbled away thanks to repeated use (and a serious shortage of small change).

In Europe, some aficionados praise the modern designs of countries such as the Netherlands and Finland. Over the past decade, most of the countries of Eastern Europe and the ex-Soviet Union have chosen to introduce new banknotes: when Belarus brought in one featuring animals, it rapidly became known as the bunny. The most attractive are said to be Estonia’s and Macedonia’s. In Afghanistan, the Afghani notes used by both the Taliban and the Northern Alliance all came from the same printer in Russia, and are equally undistinguished.

The best notes of all are, in many ways, those not printed by central banks at all. Many commercial banks have long printed their own notes: a fine collection of some printed by local country banks in Britain is currently on display at the British Museum. The big three Scottish banks still produce their own notes, although they have to be backed one-for-one by Bank of England notes.

But the purest example is Hong Kong, all of whose banknotes have always been printed by the former British colony’s commercial banks. For years, indeed, the Hongkong and Shanghai Bank acted as the colony’s de facto central bank. Even today, its notes are much admired. In the collectors’ market, old Hongkong Bank notes fetch exceptionally high prices — one note from 1867 was sold in London recently for £85,000 ($125,000).

As for the new euro notes, they mostly get low marks. They have been heavily criticised for the banality of their designs. In an effort to avoid offending anybody, they omit any images of people. The bridges and doorways that have been chosen instead are all supposedly imaginary, although one or two bear a suspicious resemblance to real-life examples. And plans to let each country add a national symbol to its notes have been dumped in favour of keeping the same designs everywhere.

That means that were Britain ever to join the euro, its notes would lose the queen’s head. This has caused spluttering among monarchists and Eurosceptics alike. Yet it is worth recalling the date when the monarch’s head first appeared on British banknotes: 1960. It should be hard to go to the barricades to defend a tradition that is less than 50 years old — but banknotes have seldom been anything other than controversial.

Copyright © 2001 The Economist Newspaper and The Economist Group. All rights reserved.