I have been writing about this for almost 40 years. America’s currency is used mostly outside the USA.
Currency withdrawn from the U.S. banking system that is not re-deposited shrinks the M1 money supply. It reverses the fractional reserve process. It shrinks the money supply.
At the 1974 Austrian scholars’ conference held at South Royalton, Vermont, I argued that black markets, contrary to popular Austrian School opinion, do reduce inflation. Black markets lead to currency transactions that are illegal. People withdraw currency to participate in these illegal markets. This shrinks the money supply, which therefore reduces both monetary inflation and price inflation. I was not taken seriously, I think. But it’s true.
Bruce Bartlett, my colleague on Ron Paul’s first Congressional staff in 1976, has written a good article on the $100 bill. These bills are sent by immigrants in the United States to their families back in the home country. The bills are not deposited in banks. They circulate as secondary currencies in those nations — inflation hedges.
Back in 1985, I was convinced that the Mexican peso was about to fall. I used a staff member on Ron Paul’s staff to ask the Federal Reserve a question. This is from the Introduction to my book, Honest Money (1986), which has been reprinted by the Mises Institute.
In the fall of 1985, I suggested to a research assistant to a Congressman that he conduct a quick study of the Mexican peso. I thought that the sharp increase in cash—American money in circulation—might be explained by Mexican nationals substituting dollars for pesos in Mexico. At the time that he began his investigation, the peso was selling for about 250 per dollar. I suggested that he ask a staff economist at the Federal Reserve System, our nation’s central bank, if he thought that Mexicans were hoarding cash dollars. I suspected that Mexican citizens were using the U.S. dollar as a substitute for the collapsing peso.
He phoned back a few days later. Two staff economists, one of whom was a specialist in the Mexican economy, had told him that it was quite unlikely that Mexicans were hoarding dollars, because Mexicans could take cash dollars to their local bank, exchange their dollars for pesos, and the bank would pay them interest in pesos.
Within one week, the peso fell to 500 to the dollar. Thus, anyone who had followed the advice of the expert economists had lost half of his capital. On the other hand, those who had bought cash dollars with their pesos and never went near a bank had doubled their money (pesos). In short, a lot of illiterate Mexican peasants knew more about practical economics in an inflationary economy than Federal Reserve economists knew. Somehow, this discovery did not surprise me.
A few months later, a report on the apparent disappearance of American cash appeared in the newspapers. It said that Federal Reserve economists now think that
people in foreign countries are using American bills instead of their depreciating national currencies. So much for the consistent views of economists. They just don’t agree on much of anything, except the need to keep economists on the payroll.
You can download this book for free here.
The FED in 1985 finally figured out where the money was going. There is nothing anyone can do about it. I am in favor of it. It keeps prices lower here than they otherwise would be.