Could cash become obsolete ?
There has been a lot of speculation that the FED will soon drive interest rates negative rather than raising even a token 0.25%. This effectively means banks will start “charging” customers to keep money on deposit. What would likely follow is a flight of cash out of the banks into the mattress.
Ultimately the goal is to encourage savers to spend cash in hopes of stimulating economic activity which remains mired in a long-term slump. Surprisingly there have been growing calls to eliminate cash completely in favor of digital currencies using justifications such as reducing money laundering, terrorism etc.
Even bankers have published articles advocating the outright elimination of cash which seems odd given their position.
A digital monetary system would make it easier to control/track/tax financial transactions in real-time, however the problems with eliminating cash are numerous but not necessarily impossible. Let’s start by examining some of the parameters of U.S. Federal Reserve Notes (FRN) and examine how practical it would be to eliminate cash for millions of people.
The total value of FRN in circulation is currently about $1.38 trillion. The $100 note represents the largest denomination and is widely used around the world. Interestingly the $100 note is by far the largest percent of total value of all currency at ~78% and has been the only denomination growing consistently. Smaller denomination notes like the $1 and $20 are typically the most widely used in daily commerce.
The first issue to address when discussing the elimination of cash is the fact that a significant percentage of all FRN are held outside the U.S. (approx. 50-70% according to FED analyses)
The implication is that most FRNs, especially the $100 note, are primarily used as international instruments driven by the reserve/petro-dollar system. Eliminating the use of $100 notes domestically would not seem to be overly problematic. Even the $50 note represents a fairly small percent of the currency in circulation and could probably be eliminated also. Foreign holders of FRN would obviously require their notes remain valid as currency instruments. The dangers in attempting to get foreign holders of FRN to send their notes back the U.S. in return for a digital currency are numerous.
So a big question is how the FED could modify legal tender laws to maintain the use of existing FRN outside the U.S. but not domestically…
Perhaps we need look no further than the Gold Reserve Act of 1934 whereby the government eliminated the gold backing of the dollar. The convertibility of the dollar into gold by foreign central banks (vis a vis Bretton Woods) however continued until 1971. So we have an example of the a bifurcated monetary system that can last for a long period.
The velocity of ‘liquid’ money (M1) has been dropping rapidly since 2009. The M1 is now effectively at the same level as the 1970s ‘stagflation’ era. This implies that cash transactions have slowed dramatically. Looking at the savings rate along side M1 we can see that apart from a rapid one-time increase in savings in 2013 there has been a rapid draw down in the savings rate ever since.
It’s possible to infer that after the 2008 financial crisis personal savings accelerated significantly until 2013 contributing to the ongoing decline in M1 velocity (saving implies not spending). It looks like velocity is flattening out as of late and perhaps we’ve reached the bottom. If cash transactions continue to decline and the savings rate flattens the impact of removing all FRN from domestic circulation may not be as bad as many are predicting.
Credit and Debit Cards:
So if the plan is to eliminate cash entirely the next question is what system would replace it ? Of course the obvious answer is credit/debit cards which are already in pervasive use across all demographics. That being said it would conceivably mean the FED handing control, of a major part of the monetary system, over to private corporations like Visa and MasterCard.
Looking at the dollar volume of credit card transactions for just Visa and MasterCard:
- MasterCard U.S. credit purchase volume: $534 billion for 2012
- Visa U.S. credit purchase volume: $981 billion for 2012
In total Visa and MasterCard process the equivalent of almost the entire physical supply of FRN on an annual basis and process a greater volume of dollar transactions than total cash held domestically.
Bank Runs and Cash:
Another justification for eliminating cash is that it makes bank runs a lot easier to control. Banks can collapse when depositors rush to withdraw cash all at once, often because a catastrophic event creates a panic. Modern banks typically create about ten times as much money as they hold on deposit through fractional reserve lending system. This means there is never anywhere near enough physical cash to cover withdrawals during a bank run.
As per Dodd-Frank legislation the FDIC is required to maintain a minimum reserve to deposits ratio of 1.35%. It has been raised to 2.0% for 2015 but that still is a tiny fraction of total bank deposits currently at $8.2 trillion dollars. Even if we assume only 50% of FRN are being held domestically ($690B) the FDIC reserves cannot remotely cover that modest amount.
Conceivably a digital monetary system like MasterCard and Visa would eliminate the concept of bank runs altogether as there would be no need to provide physical cash on demand to depositors. The potential social and political implications of this scenario however are enormous. ‘Crossing the Rubicon’ of replacing cash with digital currency units might have the effect of destroying confidence in the banking sector if there is no longer even the pretense of a physical monetary system that might limit the rate of inflation.
The idea of limiting cash transactions to fixed amounts is already standard in countries like France. The justification of fighting tax evasion and terrorism is typically the basis for these limitations although given state of the European economy the same issues of bank runs can not be discounted. Proposals to eliminate cash are now being circulated in the U.K. and many other European countries. It will be interesting to see how local communities react to cash restrictions being slowly rolled out.
Cash and the Poor:
One argument against eliminating cash is that the poor would no longer have a means of exchange as the poor tend to have less access to banking services and debit/credit cards.
While it may seem manageable if only 8.2% of all households have no banking services the individual demographics are more telling. Most noticeable 28.2% of households with less than $15k annual income have no banking services. Various minority groups also are largely without banking services.
The next logical question is what means of exchange would the poor use in a cashless society. History is full of examples where all kinds of weird things were used as currency. From cigarettes to salt to tally sticks and even in modern times Tide detergent have been used as money. Cash might actually be hoarded and used in the black market even if no longer legal tender simply because it’s still more useful than cash proxies.
New crypto-currencies like Bitcoin are an interesting potential cash alternative for the poor. Bitcoin transactions can be done on a mobile phone and with mobile phone ownership at record highs it’s not unreasonable to assume that Bitcoin might be a useful medium of exchange.
The issues of cashless societies has been debated for decades and I’ll continue to explore this topic in future posts. Global economic conditions have deteriorated to the point where the real risks of bank runs and deflation are now serious considerations being contemplated by central banks. Removing cash from circulation domestically has certain benefits to managing banking risk and would probably be a manageable process given that credit/debit cards would easily handle daily transactions.
UPDATE: The FED raised the overnight rate to 0.25% on December 16.