Overshadowed by colossal events such as Brexit, the U.S. election and the Dow nudging 20,000, investors may not have noticed an escalating war over the past year: the sinister War on Cash.
We have previously covered the ongoing “currency wars” of central banks that continually try to depreciate their currencies with lower interest rates and quantitative easing. But this goes even further because it is a war on actual, physical, paper cash.
Unprecedented Strikes Against Cash
2016 saw prominent academics and politicians shamelessly writing about the benefits of reducing or even outlawing cash. Former Secretary of the Treasury, Lawrence Summers, called for the U.S. to get rid of the $100 bill.
Former Chief Economist for the IMF and Harvard Professor, Ken Rogoff, published a book entitled The Curse of Cash, followed by numerous op-eds and endorsements by the New York Times and Financial Times endorsing a ban on cash. Australia is currently reviewing whether it will ban its $100 note.
India’s Prime Minister, Narenda Modi, announced without warning on November 8 that all 500 and 1,000 rupee notes would cease to be legal tender. Although claiming these were “high-denomination” notes, they actually equate to approximately US$7.50 and US$15 respectively, and they constitute 86% of the country’s cash currently in circulation!
Banning Cash: Rationale versus Reality
One of the biggest reasons cited for banning cash is to cut down on crime. While it is true that criminals prefer cash for the anonymity and the ease of transactions, there is no reason to believe enterprising criminals will stop their activity because transaction costs will be higher.
Criminals will easily substitute other forms of payment: lower denomination bills, other valuables like silver or gold bullion, diamonds, bitcoin, etc. Even Tide detergent has been found used as a common currency for drug trades.
The popular press surmised Tide was used by drug users because it could be stolen easily and traded for a quick fix. Yet this misses the point of why drug dealers would accept Tide as a currency at all.
The reason Tide became a currency was because it fit most of the properties of what makes a currency viable. It is recognizable (given the brand name), homogenous, easily divisible, and it has a (relatively) high value-to-weight ratio, making it portable. Bottom line: criminals are enterprising enough to surmount all kinds of obstacles inherent in illicit trade, so banning cash will not turn them into law-abiding citizens.
The next reason for banning cash is a little closer to the truth; to curb black and grey market transactions and collect all of the taxes the government is currently missing out on. India’s actions are squarely aimed at this because most Indians make virtually all daily business transactions in cash.
Further, the government will be receiving a report on any Indian citizen who deposits more than 250,000 rupees as a result of trying to rid themselves of the now illegal notes. The intention will then be to assess a tax and penalty on any of this money, if viewed by the government as unreported income.
While this may give a little boost to government coffers in the short-run, it is likely to backfire because the overall effect will be to tamp down economic activity in general, leading to even less wealth creation and less tax revenue.
The Real Reason for a Ban on Cash
The biggest reason for banning cash, especially in developed countries, is for governments to have the ability to enact even more extreme negative interest rates. Rogoff and others are actually quite transparent about this, recognizing that if banks charge an ever larger negative interest rate on deposits, savers have the option of withdrawing their money in cash and stuffing it under a mattress or in a vault, costing them less in relative terms than paying the bank to hold their money.
This highlights the ludicrous position in which central banks have put themselves, yet it is obviously the next logical step in their fallacious reasoning. To a central banker, if zero interest rates have not sufficiently spurred an economic boost with increased borrowing and spending, then the next step is to make interest rates negative, something we are already witnessing on a smaller scale.
But if minimally negative interest rates do not work, then their logic is to remove the next barrier to make interest rates even more negative. Thus the wrong intervention of the first action necessitates further interventions that distort the regular function of banks and interest rates even more.
Savers and Investors
The biggest surprise of the recent currency bans and proposals to ban currency in developed countries has been the lack of protest from citizens. Most people already use credit and debit cards for many transactions anyway and don’t seem to see the problem.
However, if negative interest rates are imposed on regular bank accounts, and savers have no way to withdraw their money, they will likely become more a lot more interested in what is really going on here. Fortunately, many alternatives exist to regular currency, and while governments may try to curb an exodus to these alternatives, it will likely be hard for them to do so, given the myriad of substitutes available.
For example, gold and silver will remain popular substitutes, as well as other alternative assets like other commodities and real estate; perhaps Tide detergent will even become more widespread as a common currency! Technology will also enable the ownership of these assets to be transferred and verified more readily.
In any case, investors and savers need to stay properly diversified and remain informed…..