The Price of Pennies: Make or Buy?

The make-or-buy decision is a fundamental aspect of economics that applies to businesses, households, and nations, with the U.S. penny providing a fascinating case study in economic inefficiency.

• It costs 2.72 cents to manufacture one penny, representing a loss of 1.7 cents per coin to taxpayers
• The U.S. Treasury loses between $85-120 million annually due to penny production costs
• There are approximately 130 billion pennies in existence, but only 5-10% actively circulate
• Most pennies end up sitting idle in jars, drawers, and coin collections after minimal use
• Arguments against pennies include production costs, inflation reducing value, transaction inefficiency, and environmental impact
• Canada successfully eliminated the penny in 2012, rounding cash transactions to the nearest five cents
• A potential alternative: buying back existing pennies at a price below manufacturing cost
• The Federal Reserve could implement a system paying $1.50 for 100 pennies, still saving over the $2.72 production cost
• This system would utilize the billions of idle pennies while maintaining the existing distribution infrastructure

Grass seed:  Expensive!

Book'o'da'week: Abortion, Baseball, and Weed 

Join us next week on Tuesday, July 1st for a new episode with a fresh topic, letters from listeners, and of course, a hilarious new TWEJ.

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You can follow Mike Munger on Twitter at @mungowitz

Chapters

• 0:00 Introduction to Make or Buy Decision
• 1:44 The Penny Production Problem
• 5:29 Current Penny Distribution System
• 8:53 Proposal: Buying Instead of Making Pennies
• 12:49 Twedges and Listener Question
• 14:48 Book of the Week and Closing

Transcript

Speaker 1: 0:01

This is Mike Munger, the knower of important things from Duke University. Today I'll be talking about the make or buy decision, but with a twist Pennies, pennies, people, two new twedges this week's letter plus book it a week and more Straight out of Creedmoor. This is Tidy C. I thought they'd talk about a system where there were no transaction costs. It's an imaginary system. There always are transaction costs.

Speaker 1: 0:33

When it is costly to transact, institutions matter, and it is costly to transact, adam Smith, in chapter 2 of book 4 of the Wealth of Nations, had this to say it is the maxim of every prudent master of a family never to attempt to make at home what it will cost him more to make than to buy. What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. End of quote. Well, what's interesting about that claim is it has now become something that's taught in business school, and rightly so. The make or buy decision is a choice that every business has to face, and if you can buy something cheaper than you can make it, you also have to factor in the possibility that maybe you can buy it now but you might not be able to buy it in the future. You want to secure access, make sure that people can't raise the price, but still, overall, the make or buy decision is a central aspect of the operation of a household, a business or, as Adam Smith says, a nation.

Speaker 1: 1:44

So there is a persistent but probably not centrally important policy debate in the United States about whether we should continue to make pennies. Some people say yes, some argue that pennies should be discontinued. There's a third alternative to we should either continue to make pennies, even though it's expensive, or we should stop using pennies at all. What we could do, after all, is buy pennies. Now, how many physical pennies exist in the US today? So if you look at the total number of pennies that have been minted since 1909, well over 500 billion, that's with a B 500 billion pennies. The current estimate of pennies actually in existence, that's not in landfills or have been torn up or unusable are at least 130 billion. That's $1.3 billion in face value. But most of it is not actively circulating. Where are all those pennies? Something like five to 10% is in active circulation. Most at least 90% is in jars, drawers, coin collections, piggy banks, your couch. Think of all the pennies that you have and then think of all the pennies that everyone else around the United States has. The US Mint produces billions of pennies annually because, despite continuing to produce all those pennies, most of them are hoarded or just put on a countertop and they don't recirculate effectively.

Speaker 1: 3:21

Well, let's think about this in terms of make or buy. What does it cost to make a new penny? In 2023, it was estimated that it cost 2.72 cents to make one new penny. Now there's metal content, it's mostly zinc, it has some copper plating, manufacturing and distribution, labor and administrative overhead Each penny. Then each penny is produced at a loss of 1.7 cents to taxpayers. So we spend 2.72 cents to get something that is worth a penny and then we use it as a penny, maybe once or twice, and then it's in your sock drawer. So the annual cost to the US Treasury is at least $85, maybe $120 million annually in losses due to penny production, and we're not getting much out of that.

Speaker 1: 4:18

So there are arguments for ending the issuance of pennies at all. It is, after all, expensive to make. Inflation reduces their value even further. So a penny that was manufactured in 1970 is now worth only 120 of its value, even in 1970. And even in 1970, it was only worth a penny.

Speaker 1: 4:39

Handling pennies adds time to any kind of cash transaction because it takes longer to make change, take up room in your pocket. Most pennies are not being used in commerce, but they sit idle. So it's a strange thing that we spend all of this time and money manufacturing these things that are used once or twice. The mining of zinc and copper in the minting process produce unnecessary waste and emissions because we're not getting much out of it. And other countries have done it. Canada eliminated the penny in 2012. Cash transactions now round to the nearest five cents. There has not been any noticeable impact, although I guess getting rid of pennies might make you talk funny. Although I guess getting rid of pennies might make you talk funny, but that's a small price. So there's 130 billion pennies at least that are actually available. Most of those are idle. Most of them are not doing anything, so we're spending a large cost for no return. It is economically wasteful, it's inefficient. It has environmental costs. Now let's think for a moment about the buy decision as it stands.

Speaker 1: 5:58

The Federal Reserve takes these newly minted pennies in fact, all US coins, but let's just focus on pennies and they follow a process for entering circulation. So pennies are minted at the US mint facilities, for the most part Philadelphia and Denver. After they're struck the pennies are counted, they're packaged in bulk containers which are bags of 50,000 coins each. So that's $500 worth of pennies. It's unlikely anyone's going to steal that, even though it's $500, it would take a while to spend 50,000 pennies. These are then transferred by truck to the Federal Reserve Banks and the different Federal Reserve districts are kind of like a federal system. Instead of 50 states we have the different Federal Reserve districts.

Speaker 1: 6:45

The US Mint sells the coins at face value and I'm making cells with quote marks. They cost a penny. A penny costs a penny. So the US Mint sells the coins at face value to the Federal Reserve Bank. The Mint ships the bulk containers of coins to the Federal Reserve Bank coin distribution centers. Then they're distributed through the coin terminals and the coin terminals are contracted with the big private armored carriers, for example Loomis, brinks, garda, there's others, but those are the big ones to operate regional coin terminals. So they have security, they have private security. They go out in those banks.

Speaker 1: 7:28

The terminals break down the bulk shipments into smaller, manageable roles. So you've got 50 pennies in a role and a box has 50 roles in it and that will go to a bank all the commercial banks that are in that Federal Reserve District. The banks then place orders for those coins from the regional Federal Reserve Bank and the armored carriers fulfill those orders and they deliver the coins to the commercial banks when they're picking up money from the banks to be deposited, money from the banks to be deposited. So then the retail businesses order change from banks as they need it cash registers, vending machines, things like that. Individual customers sometimes may withdraw rolls of coins from the bank, so the bank is selling that as a service, although it's not as a profit. Most banks, the price of a penny is exactly one penny. They're making their money off of providing other services and then, once they're in circulation, pennies move through other everyday kind of transactions, eventually returning to banks for recirculation or deposit.

Speaker 1: 8:40

Well, notice that that whole process of distribution could be changed at the production point, or at least the obtaining point. So everything would be the same if we were to buy rather than make. The difference is that all of the Federal Reserve Banks would operate a system of penny collection machines, and you've seen these change machines at grocery stores. It's just that they operate at a discount. So if you put in 100 cents worth of coins a mixture of quarters, dimes, nickels and pennies you may get 95 cents of credit for having put those coins in. That is, the coin machines have to have some way of making money. The owners of the coin machines have to have some way of making money. Well, it costs $2.72 to make a penny. Would it be cheaper to buy it? What we could have is machines at the grocery stores or at post offices for that matter. Post offices have space and they also have trucks that could ship the coins to the Federal Reserve banks for collection and redistribution.

Speaker 1: 9:59

Anyway, we have a distributed system of machines and instead of paying 95 cents for a dollar's worth of change, we could pay $1.50 for 100 pennies. So you put your pennies and the machines are able to distinguish Already. This technology distinguishes between are these washers, are they round metal pieces or are they actual coins? So that problem already exists of counterfeiting and it's unlikely that it would be worth much to counterfeit pennies anyway. But that problem has already been solved and so we could collect 100 pennies and pay $1.50. Now that seems crazy, because you say wait, 100 pennies are only worth $1. Remember, we're paying $2.72 for each of these new pennies. Why not just use the fact that there are literally more than 100 billion pennies already in people's sock drawers and on top of their counters and in jars on their kitchen counters?

Speaker 1: 11:02

If we were to buy the pennies instead and have this in a decentralized network where the Federal Reserve banks collect them and then send them to banks, we would still need some kind of process for getting the money back, retiring the older coins, and in fact you could imagine that collectors might buy something like on storage wars. So I would have the opportunity to go through a thousand or 10,000 pennies and look for old collectible pennies, and it would be a randomly selected lot and we could sort them. So it's only the old pennies that were about to retire that the collectors are going to look through, in case there are some that's actually valuable, and then they would own those and we could sell those pennies for a slight premium. It'd be a little bit of a way to raise money, because one of the objections is that if you just collect these old pennies and destroy them, well, some of those are collectible. Fine, let's see what the price is. So the bottom line here, what's interesting is we should be able to find a price that is less than $2.72. That would be sufficient for us to take care of our needs for pennies. And you might say, well, we'll get too many pennies back If we do, we'll drop the price. This would be a market price for pennies. There's just no reason to have the price of pennies be linked to one cent on the purchase side, because all it has to be is less than $2.72 and we're better off in terms of the make or buy decision. 72 cents, and we're better off in terms of the make or buy decision. Whoa, that sound means it's time for the twedge.

Speaker 1: 12:53

I have two penny jokes this time. Suppose you may have seen this. Somebody puts five pennies out on a piece of paper and say this is the five penny joke. And they move the first penny off by itself and say you smell anything? Well, that's a scent. They move the second penny over. You see that fruit it's a pear. They move the third penny over. You see the cars. Well, there's three Lincolns right there. You move the fourth penny over. See the snakes? Well, there's four copperheads. Then you move the fifth penny over. You see any law enforcement? Well, there's five coppers right there. Second twedge I put a bunch of dollars in a change machine once, but all I got back was some coins. In other words, nothing changed.

Speaker 1: 13:47

This week's letter this is from JR in St Michael's, maryland.

Speaker 1: 13:53

Jr writes why is grass seed so expensive? Well, the reason that that's a great question is that you can compare it to wheat. Wheat is basically grass seed and it's pretty inexpensive to buy bread, and bread, remember, is not just grass seed, it's grass seed that's been heavily processed. So why is grass seed expensive when it comes in the form of bread, but really expensive when it comes in bags that you get at the hardware store? And some of the answer is that wheat is grown on such an enormous scale globally that there's optimized supply chains. But it's obviously more than that. In many countries, wheat is also heavily subsidized, so those subsidies lower the cost of both raw wheat and finished bread. But that is only part of the story. Industrial bakers produce millions of loaves a day, so the production part of it, the fact that they're highly refined, doesn't add much to the cost.

Speaker 1: 14:56

The big difference is that the wheat that's used for bread doesn't need to germinate or grow, it just needs to be milled. They can be dead, they can be exposed to temperature, they can be stored. They don't have to be alive, in the sense that if they're planted they'll grow, and in fact it might be better if they don't, because otherwise they'll germinate in the bag. So it's far cheaper to have dead wheat than producing viable, high purity, genetically stable seed for planting. And that gives the big hint to the reasons why grass seed is so expensive. The first is germination viability. You have to have high germination rates or people will demand their money back. Second, you want purity and cultivar control.

Speaker 1: 15:45

I'm not selling a bag of grass seed. I'm selling a bag of Kentucky bluegrass, maybe number 51 or Bermuda hybrid or ryegrass. So it has to have strict genetic control. It doesn't matter that much if you had some different varieties of wheat or maybe even some grass in a bag of flour, but it matters a lot if you don't have 99% or more purity of cultivars in a bag of grass seed. That's what the customer is paying for, has a much lower yield per acre compared to wheat and it has to be harvested using specialized techniques, partly because we want to make sure that they're viable for germination. It has to be tested for purity. There can't be too much inert matter, there can't be weed seed contamination and we have to check germination percentage. It also goes bad pretty quickly. It's typically sold in relatively small, consumer-friendly sizes which we have to ship. For grass seed Now there's specialized packaging, labels and shipping, whereas wheat can be shipped in large containers and those containers are pretty homogeneous. We don't care if they get mixed up.

Speaker 1: 16:59

Grass seed isn't produced or bought at nearly the same volume as food crops, so it doesn't have anything like the same cost efficiencies. Interestingly, though, bread wheat and most turf grasses are both members of the I think it's pronounced Poaceae family, p-o-a-c-e-a-e. They're cousins. They're actually pretty close together in the grass world, and so the question is the seeming paradox is a good one. Why is it that grass seed is expensive and bread is cheap? As you know, you can probably get bread for two or three dollars, for a one pound loaf maybe a little bit more. Grass seed is usually five to up as much as fifteen dollars per pound, and a big part of the reason is lower economies of scale, differences in packaging, but the big differences are the necessity to ensure a single cultivar and to ensure that there are very high germination rates. Thanks for the question. That's a great question.

Speaker 1: 18:08

The book of the week. It's a book by Douglas North and Roger Leroy Miller, published in 1973 by Kotler Publishers. Douglas North, as you know, was one of my dissertation advisors. This book was written long before I met him. I hadn't even started college yet. It's called Abortion, baseball and Weed. Abortion, baseball and Weed. It is easily obtained on A-Books. It's a great summer read if you're interested in economics. It's a series of short essays about what seem like simple problems and how complex they can be when you start to think like an economist. And, as the name suggests, three of those problems are abortion, regulation, baseball and the reserve clause and weed, meaning the illegality of marijuana. So I recommend that as a summer read. It is available in paperback and is a terrific thing to sit on the beach and read. Well, the next episode will be released next week, tuesday, july 1st. We'll have a new topic, some letters and, of course, a hilarious new twedge. All that and more next week on Tidy C.