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Banning cash: this time is not different.

The Curse of Cash

By Kenneth S. Rogoff

296 pp.; Princeton University Press, 2016

Ken Rogoff is a former chief economist at the International Monetary Fund and now professor of economics at Harvard University. Just after the recent recession, he published with Carmen Reinhart a best-seller entitled This Time Is Different, an ironic and iconic title pointing to the hubris of thinking that our times were different and immune to financial crises.

As we shall see, this general idea is not unrelated to Rogoff's latest book, The Curse of Cash, in which he proposes nothing less than a government prohibition, or near-prohibition, of cash in order to cripple the underground economy and promote monetary policy He has been making this argument for two decades and has been joined by a few pundits, economists, and bankers.

The term "cash" has many meanings, all referring to liquid assets--that is, assets whose values can be realized rapidly. In its narrowest sense, cash refers to paper currency (dollar bills in the United States), which is what Rogoff and other proponents of abolition are referring to. Coins are typically not included in this definition of cash, and their value would add a mere 3% to paper currency anyway

Paper currency makes up about 10% of the total stock of U.S. money (using the M2 measure of money). The rest is essentially electronic money represented by accounting entries in the computers of banks, transferable by check, debit cards, direct transfers, and similar means. If all cash were abolished, only electronic money (and coins) would remain.

Rogoff claims to take a moderate stance. He stresses that cash would be phased out over 10 or 15 years. The largest denominations would go first, starting with $ 100 and $50 bills, and then the $20. Smaller denominations ($10 and lower) might be kept because they are useful for small transactions and for low-income people who may not have bank accounts and debit cards. But those bills might be banned too, and replaced by "equivalent-denomination coins of substantial weight." It's more difficult to become a criminal if you always have to push a wheelbarrow of money before you.

During the phase-out period, the government would replace paper currency with interest-bearing bonds, which could of course be cashed and converted to electronic money There would be no overt confiscation, except for those who chose not to turn in their money earned illegally

Whether the ban would be total or near-total, Rogoffs argument is that cash is bad because it facilitates crime and because it prevents monetary policy from pushing interest rates much below zero. The two main parts of The Curse of Cash explain these two reasons for considering cash a curse to be eliminated.

Fighting crime / Rogoff believes that reducing crime is the major reason for banning cash. He argues that cash is mostly used in criminal activities. Its advantage for criminals is that it is anonymous and that large denominations are relatively easy to transport and store.

Surveys suggest that American consumers hold less than 20% of the part of U.S. currency that circulates domestically. Moreover, 80% of the value of U.S. currency is made of $100 notes, which ordinary consumers do not often use. ("Note" or "banknote" is the technical term for a paper currency bill.) It is inferred that a large part of cash must therefore be used in criminal activities: tax evasion (notably in small, cash-intensive retail businesses), drug transactions, and other illegal transactions in the underground economy. The same appears to be true in other countries with their own currencies.

Reducing tax evasion, Rogoff calculates, would produce government revenues that would more than compensate the loss of seigniorage. Seigniorage is the difference between the government's cost of printing dollar notes and their market value.

This argument underestimates the need of a free society for institutional constraints on state power. That these constraints often benefit criminals is not a sufficient argument for depriving others of that protection. Criminals are probably more likely than blameless citizens to invoke the Fifth Amendment against self-incrimination, or the Fourth Amendment against "unreasonable searches and seizures." The Eighth Amendment, against "cruel and unusual punishments," looks even more tailor-made for criminals. But limiting government power is necessary to protect the innocent. Even the prohibition of cruel and unusual punishments does, because many innocents would plead guilty to lesser charges if the alternative in the plea-bargain offer were excruciating torture.

"It is no accident," Rogoff wrote in a Wall Street Journal op-ed previewing his book, "that whenever there is a big-time drug bust, the authorities typically find wads of cash." I suspect they also find cars. Suppose a law mandated that cars had to be equipped with factory-installed, nonremovable GPS devices and airplane-like black boxes in order to combat their involvement in organized crime. As a consequence, criminals might switch to horses and the authorities would find horses at big-time drug busts. Could one then argue that horses--that inconvenient relic of the past, just like cash--should be prohibited for everybody?

At the margin, some cost-benefit guesses are unavoidable in legislation, but banning neutral things and exercising prior controls are generally shunned in a free society, and for very good reasons. For example, alcohol is involved in about a third of crimes (according to Department of justice estimates), but that does not justify a new Prohibition. A similar argument can be made for cars, guns, and many other goods. Twitter is used by terrorists. But in a free society, deterrence through punishment is preferred to general prohibitions and prior controls.

Legitimate demand / There is obviously a legitimate demand for cash, which is used in some 60% of small purchases (up to $10). Many find cash convenient, and not only for emergencies. Even for large purchases, some individuals may have a legitimate reason to protect their privacy. Ultimately, all preferences are subjective, and economic efficiency is defined in terms of what individuals want according to their own preferences.

Interestingly, cash is one of the few goods that government seems to be efficient at producing. Such has not always been the case and it is not true in all circumstances. Rogoff documents several historical cases when governments have debased paper currency by running the printing press too fast. In today's rich countries, governments have more sophisticated ways than the printing press to debase money. So let's keep the focus on cash.

About one-half of U.S. paper currency circulates in foreign countries. In "dollarized" countries such as Panama or Ecuador, the U.S. dollar is the official currency. In other countries, people use dollar notes illegally (in view of local laws) to protect themselves against the debasement of their national currency by their own government. This happened in Zimbabwe just a few years ago after the government had printed so many Zimbabwean dollars as to render them nearly worthless. Galloping inflation became so rapid that the Reserve Bank of Zimbabwe was printing notes in denominations of 100 trillion Zimbabwe dollars.

That the poor Zimbabweans had to use U.S. cash to protect themselves against their government's exactions reminds us that not all crimes are created equal, even in Western countries. There is certainly a big difference between terrorism (where the use of cash is only "a relatively minor factor") on the one hand, and tax evasion or hiring an illegal immigrant for cash in the underground economy on the other.

On the benefit of a cash ban in fighting illegal immigration, Rogoff wrote in his Wall Street Journal piece that "it sure beats building walls." I'm not so sure, if only because banning cash is a virtual wall that would also capture citizens. At any rate, the economist venturing into normative matters would normally attach the same weight to a foreigner's welfare as to a national's. This is what the individualist methodology of economics suggests.

Built-in constraint / Furthermore, Rogoff does not see that some actions legally defined as crimes constitute useful constraints on the state. He writes that "if the government is able to collect more revenue from tax evaders, it will be in a position to collect less taxes from everyone else." This common argument assumes an angelic government that dutifully raises the minimum amount of taxes necessary to produce the public goods that all individuals want. In the real world described by public choice theory, Leviathan always lurks behind government; it will be tempted to maximize its revenues, charging what the market will bear, in order to benefit its electoral clienteles and enlarge the power and perks of politicians and bureaucrats. In this perspective, the built-in constraint of tax evasion prevents government from grabbing more money from all taxpayers.

We can extend this reasoning to the underground economy, which exists in large part because of both taxes and regulation, including prohibitions. When taxes or regulations reach a certain level, people start retreating into the underground economy, which provides a built-in brake on state encroachment. Harold Demsetz, the famed University of California, Los Angeles economist, hypothesized that as government expenditures reach 25% of gross national product (a concept closely related to gross domestic product), "the feedback system of underground transactions starts to become significant." He continued, "The feedback becomes more forceful as the government sector increases beyond 30%, making the size of that sector difficult to push much beyond 45% of real GNP in a democracy."

Writing in 1982, Demsetz may have been too optimistic about where exactly the built-in constraints of tax evasion and the underground economy stop the state's voracity. But these constraints are certainly stronger in a freer country, and that is a benefit, not a cost.

Negative interest rates / The second broad argument that Rogoff invokes against cash is that it prevents monetary policy from pushing interest rates far into negative territory, which he thinks is sometimes required. To understand this argument, a little detour into monetary theory is necessary.

Keynesian-inspired macroeconomic theory holds that recessions or slow recoveries (like the current one) are due to a deficiency of "aggregate demand." Government has to boost aggregate demand by either fiscal or monetary policy. Keynes preferred fiscal policy--increasing government spending or reducing the tax burden--but monetary policy has been fashionable lately. Monetary policy is supposed to work through the central bank pushing down interest rates and thus stimulating investment and consumption expenditures. (Real and nominal interest rates are the same if expected inflation or deflation is zero; otherwise they differ. To simplify this brief summary of the argument for negative interest rates, I assume no expected inflation or deflation, except otherwise specified.)

Pushing down interest rates will not work when they are already at zero. In theory, the central bank could continue buying bonds for more than their price at maturity, thereby pushing their yields into negative territory. It could also charge a negative rate to the banks that deposit money with it. But as interest rates go below zero, it becomes less onerous for savers and banks to keep their money in cash--that is, in dollar notes--because at least then they don't lose the negative interest. The existence of cash prevents the central bank from pushing interest rate below the zero bound constraint.

In reality, the "zero bound" constraint is not at zero, but slightly below. Storing cash is risky: it can be stolen or destroyed by fire. Secure storage, including insurance, costs something, especially for large volumes of cash--perhaps between 0.5% and 1% of the value stored. So interest rates can be pushed down to -0.5% or -1%, but not further.

A negative interest rate looks like a strange creature. It means that lenders (including holders of bank deposits) must pay to lend, and borrowers get paid to borrow. Lenders will accept this only if they think that their savings are otherwise threatened with even larger depreciation. Note that real interest rates can be temporarily negative if nominal interest rates, although positive, are lower than the inflation rate; but inflation expectations would soon push up nominal rates and correct the situation. A negative nominal interest is a new phenomenon.

During the past few years, central banks have run "quantitative easing" programs whereby they purchased bonds on the open market, bidding up their prices and pushing down their yield. Recently, they have pushed them slightly below zero in some European countries and Japan. These negative rates have not yet been passed on to bank depositors except for some large corporate deposits. In America, short-term interest rates are still positive but close to zero. If cash did not exist, the argument goes, the central bank could decisively push interest rates below zero.

Hubristic risk / There are many arguments against central banks pushing (or trying to push) interest rates below zero.

For one thing, it overestimates the state of economic knowledge. Our very imperfect knowledge of the nature of the business cycle is illustrated by the fact that economists still debate the causes of the Great Depression and even of the 2008-2009 recession. Politicians and the general public don't know more. The power of monetary (or fiscal) policy to manipulate aggregate demand is limited. We don't really know the consequences of monetary policies, especially unconventional ones like negative interest rates--except that they don't seem to show much success in Europe and Japan thus far. As The Economist observes, "Each new round of central-bank action seems to bring less stimulus and more side effects."

The argument for a policy of negative interest rates may also overestimate the influence of central banks, which is debated among economists. Do central banks exert a determining influence on interest rates or do they mainly follow broader market trends? There is no agreement on whether the currently low interest rates are a continuation of a downward market trend that started in the 1980s, an effect of monetary policy, or a joint effect of both factors. It can be argued that central banks are just accentuating the downward trend. There is much that we don't understand.

Rogoff underestimates the economic and political risk of negative interest rates. It would be too tempting for government to push rates further below zero and keep them there for longer periods in order to reduce its own borrowing costs. Exporters would exert pressure for more negative interest rates, as this should lead to a lower exchange rate and higher exports. (The lower interest rates are, the less foreign investors will want the currency.) This way, the world could end up in a protectionist race to the bottom. Negative interest rates would prove detrimental to savers, future retirees, and insurance companies.

Even if politicians and bureaucrats become saints and only manipulate interest rates in the public interest (assuming we can agree on a definition of this elusive concept), they may unintentionally generate bubbles in other markets such as commercial real estate or stocks.

Rogoff recognizes these dangers, but he has faith in government. He admits that monetary policy is plagued by ignorance and uncertainty, but he thinks that proceeding cautiously would be safe. He seems to think that, in case of ignorance, government should intervene.

It is safer to assume that politicians and bureaucrats will not become saints, so it's wise to constrain their power in the field of economic policy as in other areas. Cash provides individuals with a measure of protection against their own governments. If it becomes necessary, they can move their money over borders in cash form. If cash can facilitate private crime, it also renders government crime (by confiscation) more difficult.

Regulatory state / As Rogoff admits, a total or partial ban on cash would necessarily be accompanied by a new crop of regulations and controls. As cash is being phased out, restrictions on the maximum size of cash payments (like in some European countries) could be required. Other measures would be needed; for example, government would have to subsidize the provision of debit cards to low-income people--or supply them itself--in order for people without them to be able to use money. The spread of foreign cash would have to be prevented. Cryptocurrencies, which now provide a refuge for anonymity and privacy, would have to be regulated, perhaps with backdoors for regulators. Prepaid cards would be "discouraged," to use Rogoff's mild term. Fees on withdrawals and deposits of any remaining cash may be required. With negative interest rates, prepayment of taxes would have to be controlled and banks may need bail-outs. Many savers would no doubt ask for state help. Other regulations would be adopted to close newly discovered loopholes.

Cash hoarders would be shamed and bullied. Rogoff suggests that, after U.S. cash has been abolished, any business "that comes to the bank each week with a pile of euros might as well have 'money laundering operation' emblazoned on its stationery." He praises a British police agency that bullied banks into restricting the supply of 500 [euro] notes. As he says, government always wins anyway: "It is hard to stay on top of the government indefinitely in a game where the latter can keep adjusting the rules until he wins." Many people get the word: submit! And the rule of law rides away into the setting sun of liberty.

Welcome to the brave new world of the regulatory state. With due respect to Rogoff, his plea smacks of a naive trust of the state and a dangerous elitism or paternalism toward ordinary people who want to use cash and escape the clutches of the regulatory state.

The real question is very different from the one Rogoff considers. It is not whether government should prohibit cash, but why it supplies cash in the first place. Consider this intriguing fact: government-supplied cash helps individuals escape intrusive surveillance by government.

Supplying cash is a rather minor intervention provided that competition is not forbidden. In the United States and many other countries, legal tender laws are dead-letter. Individuals or corporations may in theory agree to deal in other currencies and use other forms of cash, although I suspect that a host of indirect regulations and bullying kill any competitive temptation. To paraphrase Rogoff, the users of other currencies would have a money laundering target painted on their backs.

Better alternative / A world where government does not supply cash and prevents anybody else from doing so--which is close to what Rogoff recommends--would be as dangerous as a world where government supplies cash and forces everybody to use it. But between these two extremes (cash ban or cash monopoly), there is a third alternative: economic freedom.

Let each individual choose whether he wants to use cash or not and in which currency, and give suppliers the freedom to respond to this demand (short of counterfeiting somebody else's currency), whether they be governments--foreign or domestic--or private suppliers, and whether their offerings are fiat money or commodity-based money (such as gold). Following Friedrich Hayek, an economics Nobel Prize winner, many contemporary economists have presented cogent arguments for allowing competition in the field of money as in other areas of life.

One thing is sure: we need another prohibition like we need another Berlin Wall.

As Rogoff would say in another context, this time is not different. Human nature has not changed, knowledge has not attained perfection, politicians and bureaucrats have not become angels, Leviathan is still lurking, and public policies can wreak havoc. Abolishing cash would increase government power, undermine the rule of law, facilitate risky monetary policies, start a cascade of new regulations, and negate individual choices and the legitimate demand for cash. It would bring another brick to the construction of the police state.

Steve Ambler, a professor of economics at the University of Quebec in Montreal's business school, says about the proposal of banning cash, "I think that the proposal is strongly tied to the desire to control, track, and tax any and all forms of expenditure." (The recent cancellation of cash and confiscation of part of it by the Indian government confirms such suspicions.)

Citizens would be well advised not to trust the state, but a state that claims to be democratic should trust its citizens. Switzerland is one of the economically freest countries in the world: in the latest ranking of the Economic Freedom of the World index, it comes in fourth (compared to the United States' 16th). It is probably significant that Switzerland has one of the largest banknote denominations in the world: 1,000 Swiss francs--equivalent to about $1,000 at the time of this writing. That is a beacon of liberty.

The Curse of Cash is a well-argued book and Rogoff is a good economist. If it were possible to prove that government should abolish cash, he would have done it. But his demonstration is not conclusive because this time is not different.


* Denationalization of Money, 2nd ed., by Friedrich Hayek. Institute of Economic Affairs, 1978.

* Economic, Legal, and Political Dimensions of Competition, by Harold Demsetz. North Holland, 1982.

* "The Fall in Interest Rates: Low Pressure." The Economist, September 24,2016.

* "The Myth of Federal Reserve Control over Interest Rates," by Jeffrey Rogers Hummel. Library of Economics and Liberty, October 7, 2013.

* "The Sinister Side of Cash," by Kenneth S. Rogoff. Wall Street Journal, August 25, 2016.

* "Where Is Private Note Issue Legal?" by William McBride and Kurt Schuler. Cato Journal, Vol. 32, No. 2 (Spring/Summer 2012).

PIERRE LEMIEUX is an economist in the Department of Management Sciences of the Universite du Quebec en Outaouais. His last book is Who Needs Jobs? Spreading Poverty or Increasing Welfare (Palgrave Macmillan, 2014).
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Title Annotation:Kenneth S. Rogoff's "The Curse of Cash"
Author:Lemieux, Pierre
Article Type:Book review
Date:Dec 22, 2016
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