Is cash really bad? Should we become a cashless society? Phasing out paper money is exactly what Harvard University economist Kenneth Rogoff proposes in this thought-provoking economic manifesto.
“The future role of cash in our society is simply too important a topic to leave in a small dark corner of monetary economics. I trust that by the end of this book, the reader will see the topic of paper currency as far from mundane and certainly not a minor issue,” writes Rogoff.
Before Rogoff argues that advanced economies have many good reasons for getting rid of paper currency, he gives us a brief history of coins and paper money. The first coins are believed to have originated in the seventh century in Lydia, corresponding to today’s western Turkey.
“The idea of having a relatively uniform transaction medium, with the government standing behind it as the guarantor of quality can be listed as one of the quantum breakthroughs in the history of civilization. Standardized coins may now seem obvious, but at the time they were pure genius,” writes Rogoff.
Taking notes
Paper money originated in China but it did not develop overnight. The idea of paper currency began when Chinese traders came up with the idea of issuing proxy notes that could be exchanged for coins. Proxy notes gave way to promissory notes so that China’s distant provinces could pay taxes. By the beginning of the ninth century, the government had taken control of the provincial note issuance system, and the use of paper money was common from the 11th to the 15th centuries. But the Chinese authorities could not resist the temptation to print paper money for finances, thus debasing the currency and triggering rampant inflation. In the reign of Kublai Khan, the government prohibited the use of gold and silver as a medium of exchange. By 1500, China abandoned government-issued paper currency, which was not reintroduced until the 19th century.
Paper money came slowly to Europe. Johan Palmstruch, a Dutch merchant, convinced the government to let him issue notes that could be redeemed at his bank for gold and silver deposited there. He eventually issued too many notes, which could not be exchanged, and he became bankrupt. A few decades later, the Bank of England also issued notes which subsequently gained acceptance as legal tender.
From 1870 until 1914, governments with gold-backed currencies kept the economies stable. But with the outbreak of World War I, several governments abandoned currency convertibility so they could print more money, thus triggering massive inflation. The gold standard was not re-established but it was replaced by the Bretton Woods Agreement, whereby currencies were pegged to the price of gold and the US dollar was seen as a reserve currency linked to the price of gold. However, in 1973 the Bretton Woods agreement came to an end, severing the link between paper money and commodities.
Illegal tender
One of the most stunning facts about paper currency is the record $1.4 trillion in US dollars alone that is circulating; much of the cash floating around is in large-denomination notes such as the $100 bill, the 500 euro note or the Swiss 1000 franc note. Incidentally, the European Central Bank will cease issuing 500 Euro bills toward the end of 2018.
The Klee study, published in 2008 and named after Federal Reserve economist Elizabeth Klee, shows that the legal economy only absorbs a limited amount of all cash holdings available in the world. This means that much of the world’s cash is part of an underground economy. The underground economy, also known as the black market, shadow market or even parallel economy, is defined as business or trade that avoids notice or observation by governments.
The parallel economy includes illegal activities such as the drug trade, extortion, bribes, human trafficking, and money laundering. It also includes small businesses which deal in cash so they can reduce their total revenues in the sight of the tax authorities.
Gabriel Zucman, author of “The Hidden Wealth of Nations” has estimated that foreign financial wealth held in tax havens totals $7.6 trillion and that the combined annual tax losses to the world’s governments due to tax havens is at least $200 billion per year. Of this $200 billion, the tax revenue loss to Europe is $78 billion and $35 billion to the US.
The drug trade involves huge amounts of cash. When the Mexican authorities arrested drug lord “El Chapo” Guzman at his home in Mexico in February 2014, $200 million in cash was found.
Cash also plays a big role in the payment of bribes. The World Bank calculated that in 2001 and 2002, the total amount of bribes was $1 trillion. If corruption still exists in advanced economies, it is even worse in developing countries. In China, when anticorruption officials arrested General Xu Caihou, who took bribes for handing out promotions, 12 trucks were needed to carry away the cash hidden in his residence.
Cashless societies
Scandinavian countries are leading the way in the move toward a cashless society. Sweden is exceptionally far ahead in the process. Many of its bank branches no longer have cash or ATMs. Furthermore, the Swedish authorities decided to phase out the 1,000-krona note, which became invalid at the end of 2013. By 2014, only a fifth of Swedish retail transactions were being conducted in cash.
“Although the Riksbank (central bank) is still printing paper currency, there are some who predict that Sweden will be effectively cashless by 2030. Cash use is still significant, accounting for about 20 percent of the number of transactions, though by value the number is far lower, perhaps 5-7 percent,” writes Rogoff.
India is the latest country to phase out large denomination notes. The Indian Prime Minister Narendra Modi, in his controversial bid to crack down on corruption, announced a ban on 500- and 1,000-rupee notes. This ban forced people with illegal cash holdings to deposit the money into bank accounts and pay taxes on it. It is said that only 1 percent of Indians pay taxes. Bill Gates praised Modi’s policy: “The bold move to demonetize high value denominations… is an important step to move away from a shadow economy to an even more transparent economy,” the Microsoft cofounder said.
In the second part of this book, Rogoff discusses the zero-rate interest policy, considered to be an important collateral benefit. Physical currency gets in the way of negative-interest-rate policy because people who don’t want to accrue negative currency can simply store their cash in a safe. Kenneth Rogoff says that “negative rates would be by far the most potent instrument available to central bankers,” but it will take decades of experience before economists can reach a strong and durable consensus.
Rogoff has spearheaded a movement for a ban on cash. By virtue of being traceable, cashless transactions can help prevent terrorist financing, money laundering, fraud and tax evasion. To this day, however, cash remains the simplest and most efficient payment technology. And most of all, cash is about freedom. A ban on cash would enable governments to exercise incredible control over all human behavior.
“The future role of cash in our society is simply too important a topic to leave in a small dark corner of monetary economics. I trust that by the end of this book, the reader will see the topic of paper currency as far from mundane and certainly not a minor issue,” writes Rogoff.
Before Rogoff argues that advanced economies have many good reasons for getting rid of paper currency, he gives us a brief history of coins and paper money. The first coins are believed to have originated in the seventh century in Lydia, corresponding to today’s western Turkey.
“The idea of having a relatively uniform transaction medium, with the government standing behind it as the guarantor of quality can be listed as one of the quantum breakthroughs in the history of civilization. Standardized coins may now seem obvious, but at the time they were pure genius,” writes Rogoff.
Taking notes
Paper money originated in China but it did not develop overnight. The idea of paper currency began when Chinese traders came up with the idea of issuing proxy notes that could be exchanged for coins. Proxy notes gave way to promissory notes so that China’s distant provinces could pay taxes. By the beginning of the ninth century, the government had taken control of the provincial note issuance system, and the use of paper money was common from the 11th to the 15th centuries. But the Chinese authorities could not resist the temptation to print paper money for finances, thus debasing the currency and triggering rampant inflation. In the reign of Kublai Khan, the government prohibited the use of gold and silver as a medium of exchange. By 1500, China abandoned government-issued paper currency, which was not reintroduced until the 19th century.
Paper money came slowly to Europe. Johan Palmstruch, a Dutch merchant, convinced the government to let him issue notes that could be redeemed at his bank for gold and silver deposited there. He eventually issued too many notes, which could not be exchanged, and he became bankrupt. A few decades later, the Bank of England also issued notes which subsequently gained acceptance as legal tender.
From 1870 until 1914, governments with gold-backed currencies kept the economies stable. But with the outbreak of World War I, several governments abandoned currency convertibility so they could print more money, thus triggering massive inflation. The gold standard was not re-established but it was replaced by the Bretton Woods Agreement, whereby currencies were pegged to the price of gold and the US dollar was seen as a reserve currency linked to the price of gold. However, in 1973 the Bretton Woods agreement came to an end, severing the link between paper money and commodities.
Illegal tender
One of the most stunning facts about paper currency is the record $1.4 trillion in US dollars alone that is circulating; much of the cash floating around is in large-denomination notes such as the $100 bill, the 500 euro note or the Swiss 1000 franc note. Incidentally, the European Central Bank will cease issuing 500 Euro bills toward the end of 2018.
The Klee study, published in 2008 and named after Federal Reserve economist Elizabeth Klee, shows that the legal economy only absorbs a limited amount of all cash holdings available in the world. This means that much of the world’s cash is part of an underground economy. The underground economy, also known as the black market, shadow market or even parallel economy, is defined as business or trade that avoids notice or observation by governments.
The parallel economy includes illegal activities such as the drug trade, extortion, bribes, human trafficking, and money laundering. It also includes small businesses which deal in cash so they can reduce their total revenues in the sight of the tax authorities.
Gabriel Zucman, author of “The Hidden Wealth of Nations” has estimated that foreign financial wealth held in tax havens totals $7.6 trillion and that the combined annual tax losses to the world’s governments due to tax havens is at least $200 billion per year. Of this $200 billion, the tax revenue loss to Europe is $78 billion and $35 billion to the US.
The drug trade involves huge amounts of cash. When the Mexican authorities arrested drug lord “El Chapo” Guzman at his home in Mexico in February 2014, $200 million in cash was found.
Cash also plays a big role in the payment of bribes. The World Bank calculated that in 2001 and 2002, the total amount of bribes was $1 trillion. If corruption still exists in advanced economies, it is even worse in developing countries. In China, when anticorruption officials arrested General Xu Caihou, who took bribes for handing out promotions, 12 trucks were needed to carry away the cash hidden in his residence.
Cashless societies
Scandinavian countries are leading the way in the move toward a cashless society. Sweden is exceptionally far ahead in the process. Many of its bank branches no longer have cash or ATMs. Furthermore, the Swedish authorities decided to phase out the 1,000-krona note, which became invalid at the end of 2013. By 2014, only a fifth of Swedish retail transactions were being conducted in cash.
“Although the Riksbank (central bank) is still printing paper currency, there are some who predict that Sweden will be effectively cashless by 2030. Cash use is still significant, accounting for about 20 percent of the number of transactions, though by value the number is far lower, perhaps 5-7 percent,” writes Rogoff.
India is the latest country to phase out large denomination notes. The Indian Prime Minister Narendra Modi, in his controversial bid to crack down on corruption, announced a ban on 500- and 1,000-rupee notes. This ban forced people with illegal cash holdings to deposit the money into bank accounts and pay taxes on it. It is said that only 1 percent of Indians pay taxes. Bill Gates praised Modi’s policy: “The bold move to demonetize high value denominations… is an important step to move away from a shadow economy to an even more transparent economy,” the Microsoft cofounder said.
In the second part of this book, Rogoff discusses the zero-rate interest policy, considered to be an important collateral benefit. Physical currency gets in the way of negative-interest-rate policy because people who don’t want to accrue negative currency can simply store their cash in a safe. Kenneth Rogoff says that “negative rates would be by far the most potent instrument available to central bankers,” but it will take decades of experience before economists can reach a strong and durable consensus.
Rogoff has spearheaded a movement for a ban on cash. By virtue of being traceable, cashless transactions can help prevent terrorist financing, money laundering, fraud and tax evasion. To this day, however, cash remains the simplest and most efficient payment technology. And most of all, cash is about freedom. A ban on cash would enable governments to exercise incredible control over all human behavior.
