Cash is a vital barbarous relic

The FT recently published a column calling for the retirement of cash, this ‘barbarous relic’ (a reference to Keynes on the gold standard in his Tract on Monetary Reform). The author takes the view that, because “by far the largest amount of money exists and is transacted in electronic form”, cash has become almost irrelevant. Worse, the little amount of cash circulating in society could “cause a lot of distortion to the economic system” and “limits central banks’ ability to stimulate a depressed economy” because people could convert their deposits into cash if the central bank decides to apply negative interest rates far below zero on deposits. And, worst of all, cash is anonymous:

The second feature of cash is that, unlike electronic money, it cannot be tracked. That means cash favours anonymous and often illicit activity; its abolition would make life easier for a government set on squeezing the informal economy out of existence.

The whole article is filled with economic fallacies and what quite a few commenters called ‘fascist’ and ‘authoritarian’ measures. While I wouldn’t go as far as qualifying such views as ‘fascist’ they are surely ‘authoritarian’, and it is frightening to see that some people (including some leading economists) are willing to give up a part of their freedom to allow central authorities (either the state or a supposedly independent central bank) to monitor and control the activities of all their citizens. Here again, as usual with interventionists of all sorts, any notion of Public Choice has been forgotten: governments seem to be well-meaning, omniscient and omnipotent organisations, which would also become omnipresent if such measures were adopted. This would give governments free rein to oppress people in a subtle way or another, whether bureaucrats were right or wrong.

One commenter, in a superb reference to Star Trek (and to the concept of separation of Church and state), summed up my view with the statement that (his emphasis)

The world needs separation of money and state, not a melting consolidation of the double helix into the Borg.

A response letter to this column is also reassuring:

The state can more easily levy a value added tax in order to make tax collection easy. How nice! Here — let me put my cash in the bank in order to make it easier for government to tax it away. Then you conclude your support of the cashless society with the caveat that we minions might, just might, be allowed to carry some cash . . . but at a cost. Our cash could carry an expiration date, for example.

As you state: “The benefits of cash are significant — but they need not be offered for free.” A more Orwellian statement would be hard to find.

But, besides the threat to liberty that a suppression of cash represents, I wish to offer here another economic reason why banning cash is a bad idea.

Cash is a control system on the banking industry. Cash, which represents banks’ reserves and most liquid assets, has been the main control tool that has kept bankers in check for centuries. The threat of deposit (i.e. claims on cash) outflow prevents banks from overexpanding, mostly through the adverse interbank clearing (mostly for individual banks) or outright withdrawal (for the system as a whole, see what happened in Greece, the most extreme version of this being a bank run) mechanisms. This is a pure market discipline effect. The fact that, in normal times, most financial transactions are done electronically is irrelevant. It is because people still have the last resort option to withdraw their deposit that makes cash such a potent control tool.

Of course, some banks are mismanaged and become illiquid from time to time. Liquidity risk is one of the main risks faced by banks and is carefully monitored, despite what some endogenous money theorists, who claim that reserves would always be supplied in case of need (while forgetting the demand side of the equation), seem to imply.

There is one option though: physical cash could be retired, as long as electronic cash could be withdrawn and stored outside of the banking system. This is the Bitcoin-solution: people can keep their Bitcoins in encrypted electronic wallets on their phones or computers, which are not accessible by outsiders (unlike bank deposits).

Retiring cash outright would however unlock a crucial financial stability mechanism, which was already weakened by the introduction of deposit insurance. Several studies have indeed controversially found that deposit insurance, which tends to reduce the pace of deposit outflow, has a detrimental effect on bank stability (see Demirguc-Kunt and Detragiache here, Calomiris here, Chu here), despite what Diamond and Dybvig claimed in their famous (but flawed) model in 1983. Far from improving financial stability and allowing central banks to ‘manage the economy’ (as if this was actually possible), the suppression of cash would be a step closer to the ultimate moral hazard.

PS: I’m also curious as to what the impact of the suppression of cash on charity would be (or for tips at restaurants and elsewhere for instance). What would you reply to the question “can you spare a coin”? “What’s your bank account number?”?

Photo: Newport webpage