Why Governments and Banks Want to Eliminate Your Cash

Scott Sumner 

In a new book called “The Curse of Cash”, Harvard economist Kenneth Rogoff advocates removing from circulation all cash with a denomination of greater than $10. In countries such as Sweden, Canada and Italy, the government is already beginning to discourage the use of cash. Almost everywhere in the world, a decreasing share of transactions are being done with cash. Are we moving towards a cashless society?

Surprisingly, despite the increasing use of credit cards, cash holdings are about 8% of GDP, which is actually a larger share of the US economy than a decade ago, indeed even larger than 90 years ago.

The amount of cash in circulation (paper currency and coins) is roughly $4500 for every man, women and child in America. It is believed that roughly ½ that total is held overseas, but even $2000/person would be a surprisingly large figure, far higher than people admit to in government surveys.

Ironically, it is this increasing popularity of cash holdings that helps explain why governments are so anxious to discourage the use of cash.

Economists study cash holdings with a model that looks at the costs and benefits of currency. Even back before 2007, people held fairly large quantities of cash, despite the fact that perfectly safe assets such as bank CDs and Treasury bills offered 3% to 5% interest. Of course cash earns no interest, and if you hold large quantities in safe deposit boxes, there’s even a small negative return on cash.

Therefore economists view the risk-free interest rate as the opportunity cost of holding cash, what you forego by not choosing a more traditional investment.

This helps to explain the recent surge in cash holdings. Since 2008, the interest rate on safe assets has been close to zero, and so there is no longer a substantial opportunity cost of holding cash. When the cost of something declines, people demand more of it. But what about the benefits of holding so much cash; why were cash holdings fairly large even back in 2007, when interest rates were well above zero?

One clue is to look at currency in circulation by denomination. The vast majority of currency (by value) is composed of $100 bills. And yet in ordinary transactions, people tend to use smaller bills, such as $1s or $20s. This is confirmed by the fact that small bills wear out pretty quickly, and need to be replaced often with newer versions at the Federal Reserve. In contrast, $100 bills wear out very slowly, suggesting they are mostly hoarded, and used only infrequently for transactions. So why is it that even back in 2007 most currency consisted of $100 bills being held for long periods, when better investments were available?

Cash has one big advantage over other investments — anonymity. There is evidence that cash is often used as a way of evading taxes. When people first hear about cash and the underground economy, they often picture gangster films with drug dealers swapping briefcases of cash. But the truth is often more mundane. Lots of cash is hoarded by people in otherwise legal businesses, who are simply trying to hide wealth from the IRS, or perhaps even their spouse. When interest rates fall to zero, cash becomes an even more appealing option.

The anonymity of cash is what makes it appealing to many people, but it’s also what makes it increasingly unpopular with governments. They see cash as a way of evading taxes, as well as facilitating drug dealing and other nefarious activities such as terrorism. Cash withdrawals of over $10,000 must now be reported to the government, and even a series of many smaller withdrawals of $3000 at a time must be reported by banks, if the pattern is “suspicious”. This is what sent former House Speaker Dennis Hastert to prison — withdrawing about $3000 at a time, from his own bank account.

Of course one problem with moving to a cashless society is the loss of privacy. If you share my libertarian leanings, you might worry about the NSA being able to find out about all of your purchases. Or a hacker might use embarrassing purchases to blackmail you. But regardless of how you feel about privacy, this seems to be the direction the world is moving.

It turns out that there is not one, but two reasons why governments are becoming increasingly anti-cash. The second reason is much harder for the average person to understand — the lure of negative interest rates...

[M]onetary policymakers [have begun] to think about a policy of negative interest on bank reserves... But one thing was standing in the way — cash [because customers would move thier funds from banks and hold them as cash if interest rates were significantly negative.]. The zero lower bound, which might in fact be closer to negative 1%, is the second reason why economists like Ken Rogoff have suggested moving away from cash. In a cashless economy, the Fed could push interest rates as far negative as they wish.