A recent article in the OC Register discussed a proposal to stop producing pennies:

Consumers could get shortchanged by a new U.S. policy to stop making pennies by early next year.

While the U.S. Treasury would save tens of millions of dollars by eliminating the 233-year-old 1-cent coin, an unintended consequence would be higher prices pushed to millions of poor consumers.

Bill Maurer, dean of the School of Social Sciences at UC Irvine, says removing the penny will harm those who don’t use bank cards or digital money options.

He pointed to two congressional proposals that he says ignore the gap between the rich and poor — the “Common Cents Act,” which was introduced by a bipartisan group of lawmakers that includes U.S. Rep. Robert Garcia, a Democrat from Long Beach, and the “Make Sense Not Cents Act.”

Both proposals would halt penny production within a year of enactment. And while the penny would remain legal tender, businesses would round cash transactions to the nearest nickel under either of the new laws — a key concern for Maurer and others.

I see two problems with the claims made in this article.  First, it seems very unlikely that the penny plays a useful role in our economy.  Second, removing the penny would not cause higher prices—indeed the reverse is more likely.

Today, the CPI is roughly 38 times higher than back in 1900.  At that time, the smallest coin produced by the US government was the penny—just as today.   In terms of today’s dollars, the Americans of 1900 chose not to produce any coins of a denomination below 38 cents.  Not only is it not at all clear that we need pennies, even nickels and dimes are of very questionable utility.  We seemed to do fine without coins of that purchasing power back in 1900.

Even in the mid-1960s (when I was about ten years old), the penny was viewed as being so worthless that children were taunted for picking one up off the sidewalk.  And yet the CPI today is 10 times higher than in the mid-1960s.

So the efficiency argument for pennies is exceedingly weak.  But what about the equity argument?  Would removing the penny increase prices, as retailers round up the price of sneakers from $29.99 to $30?  I doubt it.  It seems more likely that they would round down to $29.95.  

But even if I am wrong, even if retailers did round up prices from $29.99 to $30, removing the penny would not increase effective prices facing consumers, and would probably reduce them.  To understand why, we need to take a closer look at the dynamics of highly competitive markets.

In most of the industries where firms price at just below a round number, competition is fierce.  Examples include clothing retailers, grocery stores and gas stations.  In those sorts of industries, long-run economic profits are close to the normal rate of return in other similar competitive industries.  Any action that increases or reduces costs gets passed on to consumers.  Maybe not immediately, but certainly in the long run.

It’s a hassle for retailers to handle small coins.  Removing them from circulation would slightly reduce transactions costs (although admittedly the effect would be tiny.). Even if a few products were rounded up from $29.99 to $30, on average the price level would be slightly lower than if pennies were still in circulation, as the cost saving from reduced handling of bulky coins would eventually be passed on to customers.

This is similar to an argument I made in a previous post, which showed that regulations preventing price gouging actually result in higher prices to consumers in the long run.