Demand and Supply – the Rhythm of the Industry

Economics 101 includes, very early on, an understanding of demand and supply. Part of that story is what happens when supply is limited. And that is where we find ourselves today with banknotes. Too much demand, too little supply. The result is a scramble to secure supplies and to meet demand, with unwelcome results for buyers in particular.

We should be clear though, that this is not unusual for the banknote sector. In the 1980s new entrants to the industry were taught about the seven year cycle from peak-to-peak, trough-to-trough. As demand rose suppliers added shifts, worked weekends, brought back into service older equipment.

Suppliers then started talking to state printing works (SPW) about sub-contracting orders. As prices rose the business case for investing in new production capacity made sense, and both private and state sector actors would invest and seek to enter the market.

Shortly afterwards demand would peak. Central banks would have over ordered to safeguard themselves from running out, whatever crisis or event that had led to the surge in demand would abate, and suppliers would find themselves closing lines, reducing shifts and fighting to stay in business. Prices would fall. SPWs would leave the market and focus on their indent. Often new entrants would go out of business. Supply reduced to match demand. That was the rhythm.

What causes demand to rise?

Overspill: 'overspill' refers to when an SPW has to turn to overseas suppliers to fulfil their domestic indent. Overspill is wonderful because it absorbs all those spare shifts and idle lines and printers don't have to drop their prices for their day-to-day orders since they have the cushion of the overspill. Overspill is usually fulfilled by the larger printers, which means the smaller printers can fulfil orders of frustrated customers looking for banknote supply and finding their normal supplier otherwise occupied.

Overspill can come from a large country introducing a new series, for example. Its SPW is busy producing the new design, and the annual indent needed to tide things over until the new series is ready is outsourced. Perhaps national demand surges due to hyper-inflation, elections, demonetisation of a high value etc. Or perhaps the SPW has a problem which curtails its output – flooding, fire, a lack of maintenance, incompetence…

If there is overspill from a number of big economies, demand exceeds supply and the cycle of shortage begins.

Events: 'events' can cause sudden and massive demand shocks. It is striking just how frequent these 'exceptional' events happen.

• In the early 1990s the collapse of the Soviet Union saw a number of years of massive demand to produce currency for the newly independent states.
• Fear of a crisis linked to the year 2000 (Y2K) saw a surge in orders.
• Regime change can drive demand. While the decision to replace the Iraq currency after the war in 2003, requiring 2.3 billion banknotes to be supplied in a little over six months, is an extreme case, sudden changes in leaders and regimes often need new series to be produced.
• The 2008 Global Financial Crisis saw some countries order more notes.
• Most recently the COVID crisis did the same on a global scale, but Russia's invasion of Ukraine also led to a huge increase in cash demand of neighbouring countries.

Policy and planning: there are some obvious causes that can lead to unexpected demand.

• Poor forecasting is often at the heart of urgent orders, exacerbated by a shortage of vault space.
• Delays in ordering.
• Not managing the currency structure to ensure it is efficiently organised.
• Implementing an effective clean note policy can also drive extra demand as poor quality notes start returning.

Ripple effect: while it may be true in physics that every action has an equal and opposite reaction, an unexpected surge in demand can turn a ripple into a tsunami. If buyers are aware of a demand shock and that supply is tightening, particularly if their stocks only cover a relatively low percentage of demand, they may bring orders forward or add a little extra volume 'just in case'. The ripple becomes a wave.

Managing supply chains

Here we list a wide range of options and elements relating to managing note supply.

Stock policy: many countries divide their stocks into a 'work in progress' stock and a strategic stock of notes. The first of these can be held in branches and cash centres as well as head office. It is sufficient to manage surge demand for events – religious holidays, major sporting events, elections etc. The size of the strategic stock is a trade-off, of course, but what has happened in the past? What is likely? What is possible?

Component stocks: one of the lessons Poland learned in the wake of the invasion of its neighbour, Ukraine, is that even when you have your own SPW, if you import elements of your banknotes from abroad you are vulnerable. They may not be able to supply you in time. You should consider, therefore, holding a stock of all of the elements needed to produce your banknotes.

Reserve currencies: it has fallen out of fashion, but as recently as the 1970s some countries chose to hold a pre-printed reserve series against disaster. Some even held those series overseas in trusted countries in case they needed new notes in an extreme crisis.

Delayed note destruction: in 2008 Iceland's three largest banks collapsed, leading to an existential crisis for the country. One reason Iceland did not run out of notes was because the central bank's cash department had become uneasy about the economy and had quietly stopped destroying unfit notes. When the crisis broke it had a vault full of new notes and unfit notes (it also had an order in production with its printer).

Supply contracts: consider long term contracts/supply agreements for the supply of notes/substrates/components. The negotiation of these needs thought to work through if minimum volumes are included, if penalty clauses for a failure to supply are worthwhile etc.

Substrates: the supply of substrates can be a bottleneck, particularly if it is not widely available.

Design ownership: holding designs and material specifications so that you can switch supplier at short notice may form part of this planning. Negotiate the right to source materials if the incumbent supplier cannot meet your needs.

In-house production: a banknote production line, including the building, will probably cost you $100 million, depending on what you need. It will produce 1–1.4 billion notes a year depending on the denominational mix. While building your own SPW to give you sovereignty and control may mean normal commercial payback thinking is not appropriate, having your own SPW may be an expensive option.

Local production: one day it may be possible to have 'just in time' printing on a mini-line at the central bank. We aren't there yet with that idea, but there are examples from history of part-printed sheets being supplied to central banks who then printed the serial number and finished them off ready for issue. Perhaps some creative thinking is needed?

Final word

This article may not feel particularly helpful if you are currently facing premium prices and long lead times for being supplied with banknotes and your vault stocks are running down.

However, it does demonstrate that there are options and that with planning you can protect your bank and SPW from supply shocks.