The Penny Should Go, But What About the Nickel?

As the dollar plummets to new lows, the already limited purchasing power of the penny takes a whacking right along with it. The WSJ reports this morning that the dollar is at its lowest level since 1973 against a basket of currencies. Adjusting for inflation, a penny in 1973 is now worth $0.002 -- rounding off, the penny is practically worthless.

That line of thinking may have been behind Treasury Secretary Henry Paulson's comment on Friday that "the penny is worth less than any other currency." (At least let's hope so, because otherwise we'd have to promote him to Captain Obvious.)

Paulson also said it's time for the penny to go as the high cost of the zinc and copper that go into each penny have made it a losing proposition for the government for the past three years. At it's worst in 2006, it actually cost the U.S. Mint 1.75 cents to manufacture each one-cent penny. Given the fall in copper and zinc prices since then, it now costs about 1.2 cents to make each penny. With over 7 billion pennies manufactured in an average year, that's about $14 million of economic waste.

But the penny isn't the only coin in the red. The copper and nickel needed to produce a five-cent nickel cost 7 cents and with about 700 million made each year, that's another $14 million lost. (The dime and quarter are in much better shape.)

The case against getting rid of the penny was made by Penn State University economist Ray Lombra here and here. He argued that dumping the penny would result in a "rounding tax" that could cost consumers at least $600 million annually. That's because most prices end with a nine (such as $5.99) and without a one-cent coin these would get rounded up.

But that claim doesn't hold up when looking at real-world data, Wake Forest economist Robert Whaples countered. Examining 200,000 cash transactions at a convenience store chain, he found that when state and local taxes are factored in, there is no rounding error.

What about the nickel? Would there be a rounding tax if prices were listed at 10-cent intervals? My sense is yes, if only because there are more digits that would get rounded up than down (1-4 verus 5-9). But the role of taxes could apply here as well.

So what to do? In the past, when the cost of making a coin became too high relative to the actual value of the coin, the government has reconfigured the metals required to produce the coin -- as in the 1982 example above. The steep declines in this chart represent those times when the government rebased a coin.

(source)

But the penny has also become less and less relevant in the economy as both inflation and productivity gains make it less and less valuable:

So a good solution, borrowed from Federal Reserve economist Francois R. Velde, would be to send the one-cent coin the way of the half-cent coin, decree that all pennies in circulation are now worth five cents, and rebase the nickel so that it's made from cheaper metals.

This sort of change won't happen until at least after the elections, but it's likely only a matter of time before the nickel becomes the new penny. In fact, it already is: five cents in 1973 are now worth one cent.