The problem of cash

I found a couple of fascinating articles by Willem Buiter discussing the future of cash. They date from 2009, but are still current today. In fact, as they address the problem that cash creates in a negative rate environment, they are even more relevant now.

The "zero lower bound" (ZLB) constraint on interest rates exists because of the presence of non-interest bearing forms of money in the economy, of which the most important is physical cash. Were all money entirely electronic and interest-bearing, negative nominal rates would have become reality years ago. But where there are non-interest bearing forms of money that are near-perfect substitutes for interest-bearing forms, the view is that at the ZLB investors will switch funds to non-interest bearing forms of money rather than accept loss of principal. In short, they will hoard cash.

The effect of the ZLB constraint is to force central banks to adopt all manner of peculiar ways of forcing real interest rates below zero, because cutting policy rates directly (particularly the interest rate on excess reserves) would have undesirable contractionary effects due to the reluctance of banks to impose negative interest rates on depositors. banks believe, with some justification, that the general public objects to paying banks to keep their money safe and provide an efficient payments service. The prevalent belief is "I shouldn't have to pay to use my own money".

This neatly sums up the problem with cash. Physical cash is a free good: people do not expect to have to pay to use it, though holding it as an investment carries both cost (vaulting charges, inflation) and risk (theft, fire). And yet it could be argued that retaining physical cash as a non-interest bearing form of money when nominal interest rates on all other forms are negative is a subsidy to people who prefer cash. As I've noted before, negative interest rates are a tax. If the general economic environment is such that money is taxed, why should holders of physical cash be exempt?

At present, bank demand deposits are also exempt from the negative rates tax. But it is coming - and not just because of central bank policy. The profitability of retail banks is so awful that fees on current (checking) accounts will soon be necessary. Now, it is reasonable to suppose that for most people the convenience of modern current account banking, with electronic payments services, internet banking and the like, would outweigh the annoyance of having to pay for it. After all, free current account banking was only introduced in the 1980s: prior to that people paid fees on current accounts. The effect of this of course was to discourage use of bank accounts and encourage cash transactions: but then at the time cheques took two weeks to clear, cash deposits weren't available for three days and the only form of automated payment was standing orders, for which banks charged fees. Nowadays transaction services are far faster and more extensive, so unless negative rates were considerable, would people really return to paying bills in cash? I doubt it. There are other, better substitutes: mobile phones, for example, are providing electronic  payment services that bypass bank accounts and are effectively interest-free. If banks imposed negative interest rates on current accounts - whether because of their own profitability problems or as a response to central bank policy - we should expect to see considerable growth of non-bank electronic payment platforms. Cash is not the only problem, and these days perhaps not the main one.

But what about negative rates on time deposits? Why would people deposit money in banks if they would be charged for it? Well, they would if they wanted safety. That money is subject to a government guarantee - admittedly limited, but as long as you stay below the limit your money is safe.  So is the substitutability of physical cash really such an issue? After all, it's hardly a safe investment - and nor is physical gold, either.  You can put large amounts in a bank vault, of course, but then you will pay vaulting charges. Or you could invest in a fire safe. Or do as the Romans did, and bury coin hoards. I suppose if the US Treasury really did mint platinum coins (yes, plural - that way they could be issued to the market instead of directly to the Fed) these might be quite useful as a non-interest bearing imperishable hoard for those who are dragons at heart, even though they would be government debt really. But since they would be substitutes for interest-bearing forms of government debt, and the direction of policy is pushing both real and nominal interest rates below zero, producing coins at the moment would not be particularly clever. It would encourage investors to switch from other forms of government debt and amount to the US Treasury undermining Fed macroeconomic policy. (Mind you, as an alternative to a totally unnecessary and very harmful sovereign default it has considerable merits.)

Buiter came up with three ways of eliminating the cash problem:
  • Eliminate cash, or restrict its issue to very low denominations. 
  • Make cash interest-bearing in a similar way to coupons on bearer bonds. Of course with negative rates no-one would cash the coupons, so Buiter discusses Silvio Gesell's idea of time-stamping notes, forcing the holder to pay tax on expiry. How to stop time-expired notes from continuing to circulate in the grey economy caused considerable discussion on his first post. I think it would be virtually impossible. After all, they can't control counterfeit money, so what hope would they have of controlling this? 
  • Create a parallel "cash" currency with a floating exchange rate to the official currency
To my mind the first of these is the only realistic one. The other two are unbelievably complex. But all three would be very unpopular. Is it really necessary to go to those lengths just to eliminate a macroeconomic asymmetry?

I don't think so. The fact is that physical cash is inconvenient as a medium of exchange except for small transactions, and unsafe as an investment. So I am wondering why exactly the existence of physical cash is considered such an obstacle to interest rate policy. The obvious thing to do is to impose a levy on large holdings of cash in bank vaults, stop producing high-denomination notes (and no platinum coins either), and then stop worrying about it.

There is one very good reason for eliminating or severely restricting cash, though, which has nothing to do with either central bank economic policy or bank profitability. It is the fact that there is one sector of society that REALLY likes cash, because of its anonymity. That sector is criminals. I include in this self-employed people who work "cash in hand" to evade tax, and the people who use their services. Governments across the world are trying to clamp down on all forms of tax evasion and avoidance at the moment. Restricting cash would in theory make payments traceable and improve the information available to tax authorities, fraud investigators and the police. Although there would still be the mobile phone problem.....a payment made from a pay-as-you-go mobile phone is as untraceable as cash. And I am unconvinced that restricting note issuance to low denominations would prevent criminals using it. I could envisage forms of "shadow money" circulating among the criminal fraternity, representing claims on known piles of real money that are seldom actually drawn upon - a sort of Mafioso ETF.

But there is another reason for looking towards the eventual elimination of cash - and that is because eventually we simply won't need it. We already have instantaneous transfers of money using smart cards, and with the recent advent of contactless cards these can now be used for very small transactions. And I've already mentioned mobile phone transfers. If all you need to get lunch and coffee, or buy a pair of shoes, is a smart card or a mobile phone, why would you bother to carry cash? And if all your essential bills can be automatically paid by direct debit, and one-off bills can be paid by internet or telephone transfer, you simply don't need cash at all. In my own business now I am finding that use of cash is declining: even for single lessons people will often prefer to make an internet or phone transfer rather than pay cash, and once I am able to accept card transactions (which inevitably at some point I will do) then I expect my cash receipts to fall to near zero.

There are three categories of people for whom the elimination of cash would cause problems:
  • elderly people, who are uncomfortable with all this modern technology
  • the very poor, who don't have access to bank accounts (about 8% of people in the UK are unbanked)
  • children
None of these are liable for much in the way of tax, which of course answers my question above regarding why cash should be exempt from tax. If the people who most rely on cash are not taxpayers, then it would be unfair to tax it. 

The first of these groups will disappear in due course, since the middle-aged are already very comfortable with modern payments technology (after all, some of us invented it!). The second is a bigger problem, though the solution here is probably mobile phone technology - even the very poor have mobiles, which is of course why mobile money is becoming so important in developing countries where far more people have phones than have bank accounts. Alternatively, government may step in to ensure that the very poor have access to basic bank accounts and payment facilities. That leaves children. Not teenagers - they have mobiles, many also have bank accounts with smart cards, and schools are introducing cashless canteens. No, I mean younger children. But surely children's pocket money could be put on cash cards rather than burning holes in their pockets?

Eliminating cash would eliminate a useful source of revenue for the central bank. But as people gradually stop using cash, the central bank's seigniorage income will decline anyway. There is no reason to force the pace, and good reasons not to.  Prematurely eliminating cash would cause difficulties for some people. And it would be extremely unpopular, because people are not yet emotionally ready to accept a cash-free society. So for the moment, we need to accept that in a negative rate world grannies will stuff mattresses, skinflints will revert to cash, and some investors will behave like dragons. None of these should influence macroeconomic policy.

In my view negative rates are a bad idea because of their huge distortionary effects. I prefer Martin Wolf's suggestion that it would be better to allow inflation to be higher so negative rates were not necessary. But if central banks are so wedded to their inflation targets that they need to impose negative rates, and banks are so short of profits that they need to charge people for safe deposit and transaction services, they should do so. The existence of physical cash is no real problem.

Related links:
Willem Buiter:           Negative interest rates: when are they coming to a central bank near you?
                                The wonderful world of negative nominal interest rates, again
Miles Kimball:           Marvin Goodfriend on electronic money
FT Alphaville:            "Negative" has such unfairly negative connotations
Coppola Comment:  The strange world of negative interest rates
                                The nature of money
                                The liquidity trap heralds fundamental change


  1. A mobile pay as you go payment is certainly not as anonymous as cash. Many pay as you go systems require ID (for ancilliary services or by law in some countries) and those who don't leak ID via side channels (location, reloading, transactions, etc). To have anon pay as you go you need to buy your sim card neither from a store nor through the post, and throw it away as soon as you've used it for one transaction. Not really practical, is it?

    Banks certainly don't have to charge for current accounts, they can also charge extra on their existing non free services. The danish central bank instructed banks to charge higher rates to borrowers for instance to compensate for their negative rates.

    Also if we admit that negative rates are a tax we can as well use the tax system directly, with tax credits for investing if positive taxes on hoarding are impractical.

    1. Hi cig,

      Fair enough about mobiles - though pay-as-you-go phones are not traceable. If someone really wanted to use mobiles to make fraudulent transactions they would of course dispose of them afterwards.

      Charging higher rates to borrowers is one of the undesirable contractionary effects of negative interest rates that I noted briefly in this post and at greater length in my post on negative interest rates. The Danish banks' action supports my argument that negative interest rates are actually contractionary, not expansionary.

      I would agree with you about direct taxation. I would like to see tax incentives for direct investment in riskier enterprises. But in my view we currently have paralysis of fiscal policy and over-reliance on monetary policy - which is why we are discussing negative rates as a form of indirect taxation.

      I don't think free current account banking is remotely viable, actually - not because of the macroeconomic policy stance but because of the very difficult environment for banks. But that's a subject for another post.

  2. Interesting, with many issues.

    As you rightly point out, elimination of cash would also pose problems for criminals, including those who do "cash jobs" with a view of defrauding the Exchequer. Flying under the radar (so to speak) is widespread in the UK despite the unnecessarily draconian money laundering regulations which catch it.

    With regard to the poor, a category for whom cash elimination may be deleterious, I would argue (I would, wouldn't I ?), that the solution to this problem is to eliminate poverty. With electronic money this would be easy - the govt can simply credit bank accounts with basic income.

  3. In countries like the US and Japan where ATM Cash Withdrawal Fees are common, there is already a cost to use cash for most banked people. As Japan still mostly run as a cashed society, people resent this immensely even though this is one of the few ways banks earn a living.

    Some countries deliberately restrict high denomination from circulation by having a relatively low limit of the highest denomination note. China is one of the example with 100 Yuan (roughly £10) is the largest note. However, despite government encouragement to use debit cards, the large grey economy meant people often carry large suitcases of money to settle transactions.

    S Korea is another example of such society where 50000 Won (around £27) is the largest note though there are 100000 Won Demand Drafts available from ATM. Korea have moved to a mostly cashless society where cards reign supreme and remain a rather dynamic consumerist economy so this tells us it is doable.

    However, whether people will embrace that change is a good question.

  4. Hi Frances,

    You say, “Were all money entirely electronic and interest-bearing, negative nominal rates would have become reality years ago.” Why?

    Of course ASSUMING the government / central bank machine employs only or primarily interest rates to deal with recessions, then in recessions central banks might well want to have negative rates. That’s an assumption Buiter seems to make. But my answer to that is that employing monetary policy alone to deal with recessions is daft, for reasons I set out here:

    Here is just one reason. Adjusting interest rates brings stimulus only via entities that rely on variable rate loans. Others (e.g. those not in debt or those reliant on fixed rate loans are not initially affected). Now that makes no more sense than stimulating an economy only via those with black hair, with blondes and red heads waiting for a trickle down effect.

    Milton Friedman and Warren Mosler have both advocated that the best central bank rate is zero, and that it should stay there. I agree.

    In short, before I'm going to start worrying about negative rates and cash I want to see some very persuasive reasons as to why negative rates make sense.

    1. Saying what WOULD have happened isn't the same as saying it would have been the right thing to do. As I've explained at length elsewhere, negative nominal interest rates would have severely distortionary effects on the economy. Though I'm slightly surprised you oppose them, since they would force the adoption of full reserve banking and direct government money creation.

      However, we are in the age of fiscal paralysis at the moment, so the world is relying on monetary policy to fix everything. The whole purpose of QE and other unconventional tools has been to force rates below zero, so it is reasonable to assume that if rates could have been actually cut into negative territory they would have been. Personally I think monetary policy is pretty ineffective in a liquidity trap. I am therefore looking for an acknowledgement that fiscal policy has an important role to play - and in particular, I want to see the end of idiotic fiscal consolidation that cancels out the efforts of the central bank to reflate the economy.

  5. I see two big problems with no-cash society.

    Firstly, monetary policy would have to switch from the base interest rate view for a very minor of balance sheets to a tax-like view of the total bank balance sheets. This is a big shift in monetary policy which is ignored.

    Secondly, negative rates will generate huge profits to the central bank and government. Say for the case of eurozone a negative rate of say -2%, which is not high, applied to the total size of bank lending would result in about 350-400 bln eur annually. What are you going to do with money and how are you going to justify its distribution politically? Otherwise why bother with such a fundamental change of human mentality if you are going to charge a negative rate of -0.1%.

  6. Good post. Just some comments.

    "...stop producing high-denomination notes"

    I also thought that this would be an easy way to get around the problem. See here. Limiting denominations to $5 bills imposes storage costs and eliminates the convenience of cash.

    "There are three categories of people..."

    There's a fourth as well - the expatriate community. People/organizations who work in developing countries will often bring a big stack of $100s with them out of necessity. No $100s means big problems for them.

    1. Yes, absolutely, restricting cash issuance to low denomination notes and coins would do a lot to discourage use of cash. But following a discussion today with Miles Kimball, I would add to that taxation of large cash withdrawals from deposit accounts and smaller ones that exceeded a set frequency limit. Oh, and as I mentioned in the post, I would impose a levy on vaulted cash. I do like taxes as a disincentive....Carefully-targeted taxes would act as a negative interest rate on cash and would be a lot easier to impose. They could be crafted so the three groups I mentioned, who are not taxpayers and may have little alternative to cash, could avoid the tax. And banks would co-operate because they would then be free to charge negative rates on deposits, which they don't think they can do at the moment because of the cash alternative. Can you think of any objections (apart from popular opposition, of course)?

      No-one in developed countries uses cash in large amounts any more, except criminals (including tax evaders). However, I can see your expat community would have a problem obtaining that amount of cash to take out of the country. But don't they have problems already - money laundering rules, for example? Surely there must be some sort of licensing or permit scheme for legitimate cross-border large physical cash transfers. If not, it's probably time we invented one.

    2. "No-one in developed countries uses cash in large amounts any more, except criminals (including tax evaders).However, I can see your expat community would have a problem obtaining that amount of cash to take out of the country."

      Foreign companies and NGOs operating in African countries often hold large amounts of USD cash to use for small/medium sized repetitive payments. Some expats I know who work in West Africa withdrew $15,000 each in cash prior to departure. They'll be using it to pay their rent + other expenses. The transaction was entirely legal - they broke no laws. The landlord requires payment in cash.

      This isn't unusual since many Africans distrust the banking system. Phenomena like m-Pesa are confined to Kenya... the USD $100 is still king. In any case, if $100s were to be withdrawn, expats could always switch to the 100 euro note.

      I can see latter effect being the major objection to ending USD note circulation... the US wants to continue to hold what Eichengreen calls its "exorbitant privilege." Network effects keep the USD in this spot - killing the USD $100 could be one of the incremental changes that knocks it off its pedestal.

    3. That's a very good point regarding the US. It might suggest a parallel currency - "external" and "domestic" dollars at 1-1 parity but not exchangeable for each other. What do you think? Main problem is it increases complexity.

    4. External and internal dollars... interesting. It certainly increases complexity. Same with Miles's plan, which took a long time for me to fully understand. On the other hand, complexity makes for much better econ blog discussion. ;)

    5. I don't think there's a solution to this that doesn't involve increasing complexity. Law of diminishing returns applies, I suspect.

  7. Excellent discussion...I think let cash die naturally, through the convenience of a technological, stable society. If any aspect of our trusted resilient society is diminished cash (or metal) demand will rise (eg extended power disruption, social unrest, perceived excessive tax rates etc). Ironically, more trust in government will give rise to a diminished need for its dependable ‘promise to pay the bearer’.

    But surely the reason we are at the ZLB is because we are propping up organisations that were not viable. Those organisations have debt that ‘should’ have been written of or rescheduled. A collapse of those organisations was deemed an unacceptable social price and so they were rescued, along with many they were propping up. However, rather than reorganise them, which is difficult to do outside the trigger and legal framework of bankruptcy, we have adopted a hope for growth tactic. How to restructure a company that isn’t bust at ZLB but would be bust without an implicit government guarantee (via the banking system)? Too big to fail does not mean able to grow our way out of this land of zombie debt issuing institutions.

    Stop QE, allow failure, restructure the debt, protect those in society in the lower income quartile. Allow the organic process of creative destruction, so championed in bull markets, to take its course. Of course, this is less straightforward now that so much debt has been socialised to sovereign / tax payer level. But it will happen, whether through negative rates on cash with a maturity date or by restructuring nominal debt values or by inflation. I don’t think we can pretend the global monetary system emperor is bedecked in a Panglossian suit of stable, infinite money for too much longer.

  8. [...] Although the debate appears to be dying down, at least momentarily, Simon Wren-Lewis and Frances Coppola (see here, here, and here) have added worthwhile readings. [...]

  9. All of this pre-supposes that eliminating drugs and tax avoidance are for the public good. There are those who disagree. Taxation is extortion with menaces, and I can understand wishing to avoid it, and the illegality of drugs is a recent construct. Hence the rise of anonymous Tor clients, alternative currencies like litecoin and bitcoin which enable significantly anonymous transactions, and websites like the Silk Road, which acts like an e-bay for currently illegal substances. The mafia IOU already exists, it's a physical bitcoin.


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