The end of cash payments?

The cashless society has been in vogue lately. There seems to be a strong underlying current in society wanting to transform the way money changes hands. If there is an easy prediction to make, it would be that the days of physical cash are numbered. The process has been going on silently for a long time. Several countries in Europe have imposed cash transaction limits (e.g. Italy €3000, Spain €2500, France €1000), and even in Germany, the stronghold of cash, voices are being raised for a €5000 limit. Other countries, such as Sweden and Norway, have no formal restrictions on cash payments, but are already close to cashless in practice with people relying almost exclusively on debit/credit cards and occasionally mobile payments.

Elsewhere in the world, payments by mobile phone are gaining traction, with the M-PESA system in Kenya being the most well-known example. Interestingly, there is a rather low ca $700 transaction limit there as well, although it represents a higher value in terms of local purchasing power. Even in Somalia mobile phone payments are getting popular, albeit driven largely by a lack of a traditional banking system and the risk of getting robbed while carrying cash, if we are to believe the QZ article. Add to this the whole mania around bitcoin and blockchain technology and it becomes clear that it is a strong trend, fueled by many currents. The standard prediction is now that most cash will be gone in 10 years. Of course, for people that are into the future predictions game, in 10 years is not that imminent, because that is typically the number that people throw out, when they have no idea when something is going to happen. But clearly, the narrative and the ideas are out there and very much alive.

The recent interest in restricting cash

Curiously, there has been a flurry of news and opinions in the media during January and February about cash payments and high-denomination bills. All of a sudden, the death of cash seemed imminent! Bloomberg ran an op-ed piece calling for the end of all cash payments: Bring On the Cashless Future. Larry Summers suggested that It's time to kill the $100 bill in the Washington Post and on Feb 15th, it was reported in Germany's Handelsblatt that the process to abolish the 500 euro bills has started, although there has been no official announcement yet by the ECB. This is not surprising given the new limits on cash purchases — it makes no sense to have a 500 euro bill if the maximal transaction you can do is merely 1000 euro.

But why now? If we read Summers' article carefully, he promotes a research paper from Harvard by Sands et al., which argues against the high denomination bills. But the arguments in the paper are based on largely anecdotal evidence and rather vague: cash is corrupting, is associated with tax evasion and is generally used by the bad guys, so therefore it is logical to prohibit it. Even the nickname of the €500 bill ("Bin Ladens") is brought up as a proof for a link to terrorism, even though the actual etymology of the name is much more innocent (originally, they were called Bin Ladens because everyone knows what they look like, but few has seen them). In fact, most of arguments in the Sands paper have been raised before, for example by Kenneth Rogoff in 1998. If you follow the link to the PDF, there is a discussion following the main paper with counterarguments from other scholars, which reads quite convincingly to me, and evidently not much did happen until a short time ago. I think that the essential reason is that phasing out high denomination bills is practically the same thing as declaring a full ban on cash, because, by a proof of logical induction, banning $100 bills leads to $50 bills being used by criminals, which motives a ban on $50 bills and so forth. Therefore, ideas such as this are basically a call for a totally cashless society, which was not an option, or even desirable until now.

Cash and negative interest rate policy

Apparently, there must be a new motivation for phasing out cash, which is of more present-day relevance. That is the phenomenon of negative interest rates. In many parts of the developed world, bank accounts are yielding 0% interest, and large parts of the Treasury bond market is trading at negative interest rates. So far, the banks have resisted imposing negative rates on the savings accounts of ordinary people, preferring instead to cover the costs through hidden fees (such as credit card transactions replacing cash!) but this is compressing their margins severely and if the current economic climate continues and interest rates goes even more negative, they will have to be applied to savings accounts as well. That will undoubtedly trigger a classical bank run, where people withdraw cash from the bank to avoid the negative interest rate and being forced to spend the money. Opinions differ on exactly when this will happen, but the ballpark guess seems to be at around -2%, because while a 2% inflation is acceptable, a similar amount of deflation is directly visible as a loss in the bank account, and people tend to be much more sensitive when it comes to avoiding losses.

So the key observation is that cash effectively neutralizes the monetary effect of negative interest rates, which troubles the central banks tremendously. With the recent announcement of negative interest rate policy (NIRP) in Japan, and the general realization that NIRP might be here to stay in Europe for some time, it is not surprising that restrictions on physical cash is being promoted by banks and influential economists. It is necessary both to remove the lower bound of 0% interest rate in monetary policy and to keep the banks afloat through the increased revenues from more electronic transactions.

Cash usage statistics

It is interesting to compare the zeitgeist narrative of a revolution in electronic payments with the reality. For example, if we extrapolate the trend, when can we expect cash to be phased out in Europe? Banknote statistics for the euro can be found in the ECB's statistical data warehouse. Below, I show two graphs associated with table 1.1 from the Banknotes and Coins statistics report. Surprisingly, the trend is increasing circulation, which goes counter to the developments described above:

Apparently, the demand for the highest commonly available denomination of €50 is soaring! Furthermore, there is no indication that the use of the lower denomination bills is decreasing either. The reason given for the popularity of cash is usually hoarding behavior in Greece, due to the lack of trust in the banking system, and increasing use of the euro outside of EU in places such as Russia. So in some sense, one can say that the run on the banks has already started.

The circulation of €200 and €500 bills is increasing only roughly in line with the overall economic growth, perhaps subdued by the stigma and restrictions associated with holding them, but the like €50 bill, the mid-denomination €100 note is strikingly popular and its use has quadrupled in 10 years. Clearly, the end of cash is not in sight, at least in the eurozone.

Above, it was mentioned that Sweden and Norway are among the most progressive countries in ushering in cashlessness. But even in Norway, the number of coins and notes in circulation has been stable over the last 10 years according to the statistics by Norges Bank. In fact, only in Sweden is the cash usage actually decreasing. As per the Riksbank statistics, the number of notes in circulation decreased from 343 million in 2011 to 317 million in 2015 and the total value of cash in circulation decreased, even though the GDP grew during this period. The graph below is from the Riksbank web page linked above, showing the average value of banknotes in circulation during 2006-2015 in billion SEK:

The rate of decline still implies that cash will be around for at least 20 years more. That might explain why both Sweden and Norway are in the process of issuing a new series of bank notes. It is possible that when these series are eventually retired, it might be the last series of notes, marking the beginning of the end of physical cash in Europe.

In the light of the current strong demand for cash, it is hard to see it going away anytime soon. On the other hand, as outlined above, the policy vis-à-vis cash is not only about convenience of payments, but has also emerged as an important part of the monetary framework. The central banks and the governments have stronger incentives for forcing it out of circulation than ever before. While cash is not strictly necessary anymore from a technological point of view, other than perhaps as an emergency payment system, the sentimental and cultural value of cash is significant. It will be interesting to see how a proposal to end cash usage will presented and sold to the public. Will the argument of reducing crime and fighting terrorism be sufficient? Arguing for it from a negative interest rate perspective seems like a non-starter.

Implications of a cashless society

Finally, it seems appropriate to speculate on how going cashless might influence society. What happens when every single transaction is electronic and traceable? I think that one immediate result is a boom in various kinds of personal finance services: tools where you can drill down into all your spending, set up budgets and so forth. These exist today, we have software like Quicken and Mint in the US, and many banks offer them as part of their online services, but as they cannot easily capture all transactions without manual registration, they require some investment in time to use. When everything is transacted through the banking system, these services will be able to fully cover all our expenses automatically and immediately be much more useful. Initially, today's banks will be in pole position to offer these services without violating too much privacy, most likely branded as a "private financial advisor" powered by artificial intelligence technology, but eventually there be a strong pressure to "liberate" all the economic data from the silos of the banks and integrate it through some third party brokers and services. A coming killer application in finance might the service that manages to solve this problem in a secure way and evolve it into an independent premium service for financial planning.

Another obvious development is a change in the relation between the citizen and the government, especially its taxation office. A common argument against abolishing cash is the totalitarian aspect of a society where every economical transaction can be monitored, and ultimately tax and controlled. On the flip side, it might reduce administration and even do away with tax declaration work altogether, if you grant the tax office access to read everything. They fix it for you. This could, to some extent, reduce the size of the state apparatus. It would then be your responsibility, as a citizen, to check that they have actually deducted the right taxes. Presumably, there would be services that take care of this as well, a kind of poor man's tax lawyer. That might start a very interesting arms race between computer-based tax layers and an ever increasingly complex tax code designed to fool the algorithms.