What do attempts to counterfeit an enemy’s currency during wartime have in common with decisions to adopt another country’s currency during peacetime? Both are inspired by the power of a stable monetary standard and, conversely, the consequences of losing it. Both illustrate why preserving the value of the nation’s currency is a central bank’s most important responsibility.Money

David E. Altig

English

Research Papers in Economics

■ Buying Credibility 
Counterfeiting as weaponry is a power-
ful illustration of the value of stable
money, but it may not be the most uplift-
ing example. More hopeful lessons may
be found, not in the attempts of those
who would steal monetary credibility,
but in the aspirations and efforts of those
nations who seek it. 
Until recently, Argentina was held out 
as one such example. The protracted
downturn of the Argentine economy and
recent dissolution of its currency board
have contributed to a chorus of commen-
tary that is critical of both the objectives
and methods for economic revival
adopted by the Argentine government 
in the early 1990s. 
But the country’s recent travails obscure
the remarkable early successes of the
monetary reforms implemented at the
onset of the last decade. Between March
1989 and March 1990, the rate of infla-
tion in Argentina exceeded 20,000 per-
cent. The government responded by
promising to fix the value of the peso
such that it would trade one-for-one 
May 1, 2002
Federal Reserve Bank of Cleveland
Why Is Stable Money Such a Big Deal?
by David E. Altig
ISSN 0428-1276
What do attempts to counterfeit an
enemy’s currency during wartime
have in common with decisions to
adopt another country’s currency
during peacetime? Both are inspired
by the power of a stable monetary
standard and, conversely, the conse-
quences of losing it. Both illustrate
why preserving the value of the
nation’s currency is a central bank’s
most important responsibility. This
Commentary is based on a speech
given (jointly with Mike Bryan) to the
Cleveland City Club New Leaders
group on February 19, 2002.
On Wednesday, July 10, 1940, 
Adolf Hitler’s Luftwaffe attacked
British air bases along the coasts of
Scotland and eastern and southeastern
England. Four months later, the Battle
of Britain was over, bringing an end 
to German hopes of direct military 
conquest of the British Isles.
But the end of the air raids would not
end the attack on the United Kingdom.
Shortly after their defeat in the Battle of
Britain, the Germans began to produce a
new weapon that, while less obviously
violent than Luftwaffe bombs, was rec-
ognized as no less virulent. That weapon
was counterfeit British pounds.
Operation Bernhard, as the counterfeit-
ing enterprise would be known, was
named for Bernhard Kruger, the SS 
officer who oversaw the production of
the bogus notes by slave labor in the
Sachsenhausen concentration camp near
Berlin. By contemporary accounts, the
plan resulted in the manufacture of
about £150,000,000 in counterfeit notes
of various denominations—in the neigh-
borhood of $7 billion by today’s stan-
dards. Kruger’s operation enlisted the
support of known counterfeiters as well
as professionals and skilled tradesmen
among the camp’s population. It incor-
porated production techniques that ran
the gamut from detailed material analy-
ses to the manual labor of prisoners who
“seasoned” the bogus bills by passing
them from one another, folding and 
soiling them to give them a realistic
worn appearance.
The objective was simple, devious, and
pernicious: To undermine public confi-
dence in the pound and, by so doing,
irreparably damage the British economy.
In the end, the plot did not succeed in
destroying confidence in Britain’s cur-
rency, and eventually, the counterfeiting
program shifted toward financing vari-
ous clandestine Nazi activities outside
the United Kingdom. Ironically, this
shift in the operation’s focus was made
possible precisely because the initial
goal of undermining the pound’s value
was not realized. 
Operation Bernhard is a particularly
interesting example of the use of coun-
terfeiting as warfare, but it is by no
means unique or unprecedented. One of
the earliest known instances of counter-
feiting as a weapon occurred during the
city-state conflicts of Renaissance Italy
(the historical period that would inspire
Machiavelli’s The Prince). The instiga-
tor in this case was one Galeazzo Sforza,
a Milanese duke, who in 1470 (when
Machiavelli was an infant) attempted to
undermine the economic well-being of
his enemies in the rival city-state of
Venice by adding counterfeiting Venet-
ian currency to the corpus of general
treachery that he regularly practiced.
(History records the duke as a particu-
larly odious character, whose cruelty led
to a successful assassination plot by
Milanese elites in 1476.) 
There are many, many more examples—
some of them listed in table 1—extend-
ing through to modern terrorist aggres-
sions. The ubiquitous impulse to
undermine the value of, and confidence
in, the currency of one’s enemies is 
testament to the indispensable role of a
stable and reliable monetary standard in
modern economies. In fact, so broad 
and deep is the potential damage of a
successful counterfeiting campaign,
some reports indicate that  professional
German military officers initially
opposed Operation Bernhard partly on
the grounds that it constituted an unac-
ceptable attack on civilian populations. with the dollar. This was much more
than a simple commitment to target the
exchange rate. By adopting the currency
board, the government promised to back
circulating pesos with dollar-denomi-
nated assets, providing a constraint on
money creation and the inflation that
follows from too much of it.
The cost that establishing a currency-
board-like institution entails bears
emphasizing. To back pesos with dollar-
denominated assets, the government has
to acquire them first. There is really
only one way any country can accumu-
late the currency of another country, and
that is to give up real goods and services
in exchange. Normally, a country that
exports more than it imports today will
do so only if it anticipates being com-
pensated with imported goods and ser-
vices sometime later. But not so with
the creation of a currency board, for the
receipt of the dollar assets today is not
intended to finance the purchase of
future goods and services. The assets
instead remain in reserve to fund the
currency board, and the exports traded
for dollars today are simply the price of
buying credibility.
For years Argentina’s purchase of credi-
bility appeared to be a wise one. The
country’s inflation rate plunged almost
immediately, and by 1998 inflation was
a mere 1 percent. Furthermore, after
stagnating for decades, the economy
expanded at a pace of over 4
1/2 percent
per year.
■ Necessary, but Not Sufficient
Even at the height of success, however,
there were indications that the currency
board was not an absolute panacea. The
perception that the peso remained a rel-
atively risky bet was hard to shake, and
investors in peso-denominated securities
demanded higher interest rates as com-
pensation for bearing this risk. What’s
more, the magnitude of the risk premia
tended to be quite volatile, suggesting
that the economy remained susceptible
to speculative attack.
In January 1999, then-President Carlos
Menem proposed complete dollariza-
tion, in effect eliminating the peso
entirely. Although dollarization would
have had little technical advantage over
the existing currency board arrange-
ment, many proponents of dollarization
argued that markets had retained some
residual doubt about the long-run 
viability of the board, doubts that only
complete elimination of a circulating
peso would vanquish.
But the drive for dollarization was not 
to be, and the fears that the currency
board would prove unstable were all too
prophetic. As of February 11, the peso
was wholly untethered from the dollar,
and the last vestiges of the currency
board, in the process of being dismantled
since late last year, were finally reduced
to rubble.
The advocates of dollarization may have
seen it coming. Argentina had begun the
recession from which it has yet to
recover in mid-1998, as fears mounted
that the faltering Brazilian economy
would place irreparable strains on the
Argentine economy. The problems of the
country, however, appear to be more fun-
damental than the details of its monetary
arrangements. Writing in the January 9
edition of the Wall Street Journal, the
Cato Institute’s Brink Lindsey quoted a
survey conducted by Harvard University
and the World Economic Forum’s 2000
Global Competitiveness Report showing
that, of 59 countries studied, Argentina
ranks “40th in frequency of irregular
payments to government officials; 54th
in the independence of the judiciary;
55th litigation costs; 45th for corruption
of the legal system; and 54th in the relia-
bility of police protection.” (The ques-
tions of the survey were asked such that
high numbers are bad.)
These statistics reveal an overwhelming
fault in Argentina’s political infrastruc-
ture. It is not surprising that truly inde-
pendent central banking could not be
sustained in such an environment. As if
to underscore the point, the disintegra-
tion of the currency board took shape in
May 2001 when Fernando de la Rua dis-
missed Pedro Pou, the central bank gov-
ernor, for resisting attempts to weaken
the country’s promise of peso parity with
the dollar. 
In the case of Argentina, the reforms that
gave rise to the currency board were not
sufficient in the absence of broader insti-
tutional reform. But that fact should not
mislead us into the false belief that long-
term prosperity can be achieved in
Argentina (or any country) without a
strong, stable, and credible monetary
standard. A currency board, dollariza-
tion, or the like may not be a sufficient
condition for prosperity, but it is cer-
tainly a necessary one. 
■ A Sacred Trust
The story of Operation Bernhard—but
one example among many instances of
counterfeiting in times of war—gives us
an idea of the perceived damage that can
be inflicted on an economy by under-
mining confidence in the country’s abil-
ity to maintain a stable purchasing
power of money. So crucial is this confi-
dence that counterfeiting attacks appear
to be nearly as common a weapon in
warfare as bombs and bullets.
The example of Argentina underscores
the large gains that price stabilization
can bring. But it also illustrates how dif-
ficult it can be to obtain credibility when
it is absent, and how tenuous its footing
can be once attained. 
Central bankers often emphasize that
their core long-run responsibility is pro-
tecting the purchasing power of money,
and that maintaining price stability is the
primary way that monetary policy can
contribute to sustainable long-run
growth. It can be difficult, perhaps, to
appreciate the power of these sentiments
in an environment where the value of
money does not appear to be seriously at
risk. But to consider the alternative—to
consider the motivations of nations that
would steal that value from their ene-
mies and the distress of those nations
that lose it—is to understand why pro-
tecting the credibility of an economy’s
monetary standard is the mission of a
central bank. 
■ Changing to Stay in Place 
The issue is not one of trading the gains
of price stability against other objectives
of monetary policy. The key point is that
none of those other objectives can possi-
bly be met if the public isn’t convinced
that the central bank will fulfill its
responsibility to protect the purchasing
power of money.
Unfortunately, the perception that mon-
etary policy objectives conflict with one
another is held by too many too often. In
particular, people believe that containing
inflationary pressures requires a central
bank to restrain economic growth. This
perception is reinforced, I think, by a
general misunderstanding of federal
funds rate decisions, the monetary pol-
icy actions that are most visible to the
public. Specifically, people are confused
about the distinction between changes in
the federal funds rate that are designed
to engineer changes in the real economy
versus changes that are reactions tochanges in the real economy. Chairman
Greenspan made these distinctions clear
during his March 7 testimony before 
the Senate Committee on Banking,
Housing, and Urban Affairs. 
“We did raise interest rates in 1999, and
the reason we did is, real, long-term
rates were beginning to rise because the
economy was beginning to accelerate.
Had we not raised the federal funds rate
during that particular period, we could
have held it in check only by expanding
the money supply at an inordinately
rapid rate...” 
To put the idea in a slightly different
way, in some circumstances changes in
the federal funds rate are nothing more
than the adjustments required to strike a
neutral stance in monetary policy. This
is the theme of the Chairman’s com-
ments above, a theme explored at length
in the economic essay of this year’s Fed-
eral Reserve Bank of Cleveland Annual
Report. It is a motivation for central
bank interest rate policy that needs to be
better understood. 
■ You Don’t Know What
You’ve Got ‘til It’s Gone
The day will come when the Federal
Open Market Committee will again see
fit to raise the federal finds rate. The
magnitude, timing, and precise ratio-
nale of these changes are, of course,
uncertain. But the basic issues are not.
Nations attack their enemies by attempt-
ing to undermine confidence in their
adversaries’currency. Governments pay
tangible costs in goods and services to
attach themselves to credible foreign
monetary standards, and pay yet more
when those arrangements prove insuffi-
cient to instill confidence in the coun-
try’s currency. All of this is everywhere
and always about the purchasing power
of money, and the role that sustaining it
plays in promoting economic prosperity.
The public is sometimes confounded by
the willingness of central banks to act
in times when the threat of inflationary
pressures does not appear imminent.
Some of this reflects an underapprecia-
tion of the fundamentally defensive
nature of many changes in policy rates,
such as the federal funds rate. Many
times, changes in these rates are mere
reactions to the evolving pressures on
interest rates more generally, designed
to maintain the existing thrust of policy
rather than to “tighten” or “ease.”
But even in those cases where a more
activist stance is implied by particular
policy choices, it ought to be remem-
bered that, ultimately, economic growth
and price stability are not in competi-
tion, and that a relaxed attitude toward
preserving the value of money can
quickly devolve into trouble. In the
middle and later parts of the 1960s, sta-
ble inflation expectations were taken
for granted and even exploited, ulti-
mately to ill effect. Arguably, the infla-
tionary problems of the 1970s can, at
least in part, be traced to an overly san-
guine attitude toward the fragility of
price stability in the 1960s. The proof
that faith in an economy’s monetary
standard is a precious commodity is in
our history, and the history of others,
from Renaissance Italy to Nazi Ger-
many to the United States in the 1970s
to the present situation in Argentina.
The goal of central banks all over the
world is to avoid relearning this lesson.
■ Recommended Reading
Altig, David E., and Owen F. Humpage.
1999. “Dollarization and Monetary Sov-
ereignty: The Case of Argentina.” Fed-
eral Reserve Bank of Cleveland, Eco-
nomic Commentary (September 15).
Altig, David E., and Ed Nosal. 2002.
“Why Haven’t Long-Term Interest
Rates Fallen?” Federal Reserve Bank of
Cleveland, Economic Commentary
(January 1). 
Counterfeit Notes of War, http://cur-
rency_den.tripod.com/War_Counter-
feits/war.html.
Federal Reserve Bank of Cleveland.
2002. “Rhetoric Aligned with Theory:
Talking Productively about Interest
Rates.” Federal Reserve Bank of 
Cleveland, 2001 Annual Report.
Pirie, Anthony. 1962. Operation Bern-
hard. New York: William Morrow and
Company.
Entity engaged in
Conflict counterfeiting Currency counterfeited
Italian city-state conflicts (1423–1508) Milan Venetian ducat
American Revolution (1775–83) Britain Colonial currencies
Napoleonic Wars (1805–12) France Austrian Banco script notes
Russian rubles  
Mexican–American War (1846–48) Mexico Republic of Texas dollars
U.S. Civil War (1861–65) United States Confederate States of America dollars
World War I (1914–18) Britain Turkish lira
Bolshevik Revolution (1917–21) White Army Russian rubles 
World War II (1939–45) Britain Burmese rupees
Chinese yuan
German reichsmarks
Malaysian dollars
Germany British pounds
French francs
Hungarian pengos
U.S. dollars 
Yugoslav dinars 
Japan Chinese yuan
United States Burmese rupees
German reichsmarks
Japanese yen
Bay of Pigs Invasion (1961) United States Cuban pesos 
Vietnam War (1964–73) United States North Vietnamese dong 
Terrorist activities (1990–96) Unknown U.S. dollars  
Sources: Counterfeit Notes of War, <http://currency_den.tripod.com/War_Counterfeits/war.html>,
accessed April 8, 2002; “Counterfeit U.S. Currency Abroad: Observations on Counterfeiting and U.S.
Deterrence Efforts.” 1996. Testimony of JayEtta Z. Hecker to the House Subcommittee on General 
Oversight and Investigations, Committee on Banking and Financial Services, GAO/T-GGD-96-82, 
U.S. General Accounting Office.
TABLE 1  EXAMPLES OF COUNTERFEITING IN WARFAREFederal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101
Return Service Requested:
Please send corrected mailing label to
the above address.
Material may be reprinted if the source is
credited. Please send copies of reprinted
material to the editor.
David E. Altig is the associate director of
research and a vice president and economist  at
the Federal Reserve Bank of Cleveland. He
extends special thanks to Roland Rollins, Web
master of the Currency Den < http://currency_
den.tripod.com/ War_Counterfeits/ war.html >,
and Louis Jordan III, head of special collections
and the Medieval Institute Library at the 
University of Notre Dame, for invaluable help
with data and sources. He also thanks Shadya
Yazback for outstanding research assistance and
John Carlson, Joe Haubrich, Jerry Jordan, 
Ed Nosal, and Mark Sniderman for helpful 
conversations that contributed to the ideas in
this Commentary.
The views expressed here are those of the
author and not necessarily those of the Federal
Reserve Bank of Cleveland, the Board of Gover-
nors of the Federal Reserve System, or its staff. 
Economic Commentary is published by the
Research Department of the Federal Reserve
Bank of Cleveland. To receive copies or to be
placed on the mailing list, e-mail your request
to 4d.subscriptions@clev.frb.org. Economic 
Commentary is also available on the Web at:
www.clev.frb.org/research.
PRSRT STD
U.S. Postage Paid
Cleveland, OH
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Why is stable money such a big deal?

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