While modern monetary theory has provided some distraction for public and commentators alike, the war on cash goes on. In the latest issue of the Cato Journal, the distinguished economic historian Michael Bordo and his co-author Andrew Levin lament the failure of the experiments in unconventional monetary policies of the last decade to stimulate aggregate demand. While they detail these failures at length, they do not draw the conclusion that there is something fundamentally wrong with the dominant approach to monetary policy – rather, the problem is that the effective lower bound (ELB) on nominal interest rates has prevented central banks from providing “sufficient” monetary stimulus. After all, cash is interest-free, so zero or negative interest rates cannot be imposed on the economy, as people will simply shift their savings from bank accounts into cash holdings.
Clearly, something must be done to overcome this problem. It has long been recognized (e.g. by Professor Salerno) that one of the main motives in the war on cash is to overcome the ELB: eliminate cash and there will be no limit to how low the Federal Reserve can go. Professors Bordo and Levin do not wish to go that far – at least initially. Rather, they suggest that “digital cash” be established as the fulcrum of the U. S. monetary system (p. 384).
Their scheme, briefly, is as follows: digital cash should be provided in designated accounts at supervised depository institutions, which in turn would hold part or all of these funds in reserve accounts at the central bank. These digital cash accounts would earn interest and this interest rate would become the central bank’s main policy tool: in normal times, it would be positive, but in times of crisis the central bank would be able to cut the rate below zero. We’re assured by the good professors that individuals and firms would still be free to use physical cash. It’s just that digital cash will be so dang convenient that the demand for physical cash will rapidly disappear. But just to make sure, fees should be imposed on transfers from digital to physical cash so there are no incentives to arbitrage in the case of negative interest rates on digital cash.
There is a lot to criticize in this proposal.
In its totalitarian implications, it is similar to Rogoff’s book The Curse of Cash, which they cite approvingly. It is also extremely one-sided. For instance, a token-based system of digital cash (think bitcoin) is portrayed as prone to fraud, but we are lead to believe that no such problems exist when it comes to their favored form of digital cash. Their assurances that private individuals will not have to pay negative interest rates ring hollow; for once everybody is in the system, what is to stop the benevolent central bank from changing the rules on who is and who isn’t exempt from the negative rates? And once the fee on transfers between digital and physical cash is in place, why not make physical cash prohibitively expensive? Ultimately, the public is forced to use the financial system, negative interest rates are imposed as thought necessary by the central bank, and the ability to convert money into physical form is severely curtailed, if not completely abolished.
One is also struck by their curious proposition that physical cash has an opportunity cost in the form of the foregone interest on a risk-free investment while digital cash will earn interest and therefore have no opportunity cost (p. 398).
In other words, cash does not yield anything and is, therefore, an inherently worse form of money than digital cash, which will earn interest comparable to T-bills. (The good professors do not seem to recognize that they are contradicting themselves: digital cash is preferable both because people earn interest on it and because it allows for the imposition of negative interest rates?) They seem to think that money is just another financial asset, albeit a more liquid one. Monetary policy therefore boils down to managing relative interest rates: if only the spread between the interest rates on digital cash and financial assets can be maintained, there is no reason why people should not continue to be fully invested throughout a possible crisis (p. 402).
The problem is that money is not a financial asset and physical cash is not, contra Bordo and Levin, sterile. Rather, holding cash serves an important function: as Hoppe lucidly explains, holding money is an investment in certainty.
Since we can never know with complete certainty when and what we want to buy or at what prices we will be able to sell our goods and services, we always have some money on hand. The more settled and certain conditions are, the less cash reserves a person will think it necessary to keep. But in a financial crisis, uncertainty spikes again and he will, therefore, increase his cash reserves to guard against this increased uncertainty until conditions quiet down again.
Professors Bordo and Levin can perhaps be forgiven for not knowing of Hoppe’s argument — and perhaps even for ignorance of the works of Hutt and Mises on which Hoppe builds — but a recent paper from the Bank for International Settlements makes essentially the same point: despite official hostility to cash and advances in payments technology, demand for cash has risen since the Great Financial Crisis, as people turn to cash as a store of value.
Should their proposal be implemented, it is far from certain that the outcome in the event of a crisis will be what Professors Bordo and Levin desire. Physical cash will have been eliminated as a safe haven, but digital cash will be an inherently bad way of preserving purchasing power when negative interest rates are threatened. A likely outcome will therefore be that savers look for alternatives to cash to preserve their wealth. One such alternative is investing in gold, an asset that has a long track record of maintaining its value in the long term.
Rather than securing the monetary system, the digital system outlined by Professors Bordo and Levin would further empower central bankers at the expense of consumers.
